The IRS deems taxable income as one of two types: ordinary and capital gain. Most income is considered ordinary and includes:
- Salary or hourly wages
- Interest income
- Self-employment income (e.g., freelancing or otherwise running your own business)
- Rental income
Capital gains income result from the selling of certain personal items for more than you paid for them. Examples of transactions which can trigger capital gains include:
- Stocks sales
- Mutual fund sales
- Home sales
There are two kinds of capital transactions: short-term and long-term. Short-term transactions occur if the sale happens a year or less after the purchase. Short-term capital gains are taxed as ordinary income. However, long-term capital gains (where the taxpayer owned the asset for more than one year), are taxed at capital gains tax rates.
At most times in our history including today, top ordinary income tax rates exceed top capital gains tax rates. Consequently, you’d prefer income from a capital gains transaction over the same event triggering ordinary income.
Calculating Capital Gains and Losses
To determine the extent of a capital gain or loss, you simply subtract your cost of the asset you sold from its sales price. If your cost is less than the sales price, you have a capital gain. Your long-term gain will be taxed at 0%, 15%, 20%, 25%, or 28% depending on your income. If your cost exceeds your sales price, you have a capital loss. You can deduct up to $3,000 in capital losses from your income. If your capital losses are more than $3,000 you can carry them forward to the next tax year.
Don’t worry about knowing how to calculate capital gains if you sold personal property. TurboTax will ask you simple questions and do the calculations based on your entries.