The sale of a capital asset will result in a capital gain. Depending on the holding period of this asset, the gain will either be short-term or long-term. Long-term gains have a lower, preferred income tax rate. The holding period begins on the day the asset is purchased, as measured by the trade date, to the day the asset is sold. Assets that are inherited are deemed to be held long term.
Capital Assets Include:
Short-Term Capital Gains
Short-term capital gains result from the sale of capital assets held one year or less. Short-term capital gains are taxed at ordinary income tax rates. The highest federal ordinary income tax rate for a married couple filing a joint return for 2010 was 35% on taxable incomes of over $373,650. These tax brackets are adjusted for inflation annually by the Internal Revenue Service ("IRS").
Long-Term Capital Gains
Long-term capital gains are from the sale of capital assets held longer than one year. These gains are taxed mostly at 15%. In 2011 for married couples filing a joint tax return whose taxable income is below $69,000 there is no capital gains tax. A large long-term capital gain relative to the other income declared by a taxpayer may result in an Alternative Minimum Tax ("AMT"). The highest stated rate of the AMT is 28%. The reality is, depending on the facts and circumstances a taxpayer subject to an AMT may pay a tax rate anywhere between 15% and 28%.
There is a tax advantage with capital losses. Gains and losses need to be categorized as short-term and long-term. If the net is a loss a taxpayer is allowed to deduct $3,000 of the capital losses and carry forward the balance of the losses into future years. Unfortunately, unlike many other provisions of the tax code, this $3,000 limit on capital losses has not been adjusted for inflation in decades.
Capital gains transactions are recorded on Form 1040 Schedule D. With the filing of the 2011 returns, there is a new IRS Form, 8949, Sales and Other Dispositions of Capital Assets, which is currently in draft form. This form will be completed and the totals will be transferred over to Schedule D.
The IRS is also revising Schedule D (draft version) and Form 1099-B. Starting in 2011 Financial Institutions will have to include cost basis information directly on to Form 1099-B. Therefore, Schedule D will function as a summary of all capital gains transactions.
ACTION ITEM: It's important for taxpayers to understand the difference between short-term and long-term capital gains.
Thomas F. Scanlon, CPA, CFP®