Capital Gains & Losses: Definition & Statutory Framework

Instructor: Martin Gibbs

Martin has 16 years experience in Human Resources Information Systems and has a PhD in Information Technology Management. He is an adjunct professor of computer science and computer programming.

If money is made (or lost) on an investment, the IRS would like to know. This lesson will define capital gains and losses and explain the tax framework for the different types of gains and losses.

Capital Gains and Losses

When you sell an investment or property, you incur a capital gain if you get more than you paid for it. If you held the asset more than one year, the gain is long-term; if held for less than a year the gain is a short-term gain.

On the other hand, a capital loss is the opposite: You sold the asset for less than what you paid.

We often think of capital gains (and losses) in terms of stocks and other investments. But the rules apply to real estate and other securities.

Tax Laws

The tax laws for capital gains and losses can get complicated. Not all gains and losses are the same. If a gain or loss does NOT trigger taxation rules, it is considered unrealized. (We'll get to those later.) Realized gains or losses may be taxed. In other words, you made (or lost) the money, and now the IRS wants some of it.

But the actual taxation of the gain is a little more complicated. It all depends on your tax bracket. Let's take a look at each type of gain (or loss) and the tax implications.

Short-Term Gains

Short-term gains follow the tax brackets of your standard income. If you are being taxed at 25%, that is the tax you will incur on short-term gains. Think of the day trader who constantly buys and sells stocks: Any gains made should be considered part of normal income, because this activity most resembles the daily work most of us do.

However, if you hang on to your investment for more than a year, you are spared the traditional tax treatment (for the most part).

Long-Term Gains

Long-term gains (those held over one year) have a little more relaxed policy. The tax rates are 0, 15, and 20%. Even if you are in the 30 percent tax bracket, your maximum tax on a long-term gain is 20%.

The following table highlights the capital gains rates compared to the tax brackets.

Tax Bracket Capital Gains Tax Notes
15 - 15% 0% Helpful for retirees who have no taxable income
25, 28, 33, and 35% 15% Also applicable to some dividends
39.6% 20% Also applicable to dividends
N/A 25% gains rate Applicable to real estate that was depreciated
N/A 28% gains rate Small-business stock and sales of collectibles

Losses

Let's say we invested in a mutual fund in 2014; we paid $5,000. In 2016, the value dropped to $2,500. We held it, keeping the unrealized loss (we'll get to that idea shortly), but then cut our losses in 2017 when the amount was $4,500. We almost made the money back but still had a loss of $500. We can only deduct the $500. This is because we sold the investment in 2017, not 2016.

There are differences between long-term and short-term losses, just as there are with gains. Yes, the time-frame is the same for each. The tax law requires that you net each type of loss against the matching gain.

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