Does Taxable Income Include Capital Gains?
While profits from assets are taxable, they are not treated like your salary. Understand the factors that determine your tax liability on investment gains.
Yes, taxable income includes capital gains, but they are often taxed differently from income like wages or salaries. Taxable income is the portion of your gross income subject to tax after allowable deductions and exemptions. It encompasses various types of earnings from employment, business activities, and investment returns.
Defining Capital Gains
A capital gain is a profit from selling a capital asset for more than you originally paid for it. The Internal Revenue Service (IRS) defines a capital asset broadly as almost everything you own for personal or investment purposes. Common examples include stocks, bonds, real estate, and collections, as well as personal items like a car or household furnishings.
A capital gain is the sale price of an asset minus its adjusted basis. The cost basis is the original purchase price, which can be adjusted for costs like commissions or factors like depreciation. For example, if you buy a share of stock for $100 and pay a $5 commission, your cost basis is $105. If you later sell that share for $150, your capital gain is $45.
This profit is a “realized” gain and must be reported on your tax return for the year of the sale. Keep accurate records, such as trade confirmation statements, that document the purchase price and associated costs to correctly calculate your basis. Brokerage firms report proceeds from sales and basis information for many securities on Form 1099-B.
Short-Term vs Long-Term Capital Gains
The tax treatment of a capital gain depends on the holding period, which is how long you owned an asset before selling it. This duration classifies the gain as either short-term or long-term, directly impacting the tax rate applied to your profit.
A short-term capital gain results from selling an asset you have held for one year or less. The holding period is calculated from the day after you acquire the asset up to and including the sale date.
Conversely, a long-term capital gain is the profit from selling an asset owned for more than one year. Holding an asset for at least one year and one day before its sale results in a long-term gain.
How Capital Gains Are Taxed
Short-term capital gains are added to your ordinary income, such as your salary, and taxed at your regular federal income tax rate. For 2024, these rates range from 10% to 37%, depending on your total taxable income and filing status.
Long-term capital gains are taxed at lower rates of 0%, 15%, or 20%, depending on your taxable income. For single filers in 2024, the 0% rate applies to taxable income up to $47,025. The 15% rate applies to income between $47,026 and $518,900, and the 20% rate applies to income above $518,900.
For those married filing jointly, the 0% rate applies to income up to $94,050, the 15% rate to income between $94,051 and $583,750, and the 20% rate to income over that amount. High-income taxpayers may also be subject to an additional 3.8% Net Investment Income Tax. Gains from specific assets, like collectibles, are subject to different rates, such as 28%.
The Role of Capital Losses
When you sell a capital asset for less than its cost basis, you incur a capital loss. These losses can offset capital gains to reduce your tax liability. Short-term losses are first used to offset short-term gains, and long-term losses are used to offset long-term gains.
A net loss in one category can then offset a net gain in the other. For example, a net short-term loss of $2,000 can reduce a net long-term gain of $5,000 to a taxable gain of $3,000. This netting process is reported on Schedule D of Form 1040.
If your total capital losses exceed your total capital gains, you can deduct the excess loss from other income, like your salary. This deduction is limited to $3,000 per year ($1,500 if married filing separately). Any remaining net capital loss beyond this limit can be carried forward to future tax years.