Gains and Losses from the Sale of Capital Assets
Almost everything you own and use for investment and for personal purposes (i.e., not for trade or business) is a capital asset. For example, if you own shares in Company X, those shares are capital assets. If you were to sell those shares (or any other capital asset), the resulting gain or loss from the sale would be either a capital gain or capital loss.
Capital gains and capital losses are either short term or long term, depending upon the length of time you held the capital asset prior to selling it. A capital gain or loss is short term if you held the capital asset for one year or less. If you have held an asset for more than one year, then any capital gain or loss would be long term.
Whether a capital gain or loss is classified as short term or long term can have significant tax implications. Whereas a short-term capital gain is taxed as ordinary income, a long term capital gain is taxed at a preferential rate lower than your ordinary income tax rate. Long-term capital gains are subject to tax at either 0 percent, 15 percent, or 20 percent, depending upon your filing status and taxable income.
If you sold multiple capital assets during the course of a tax year, it is likely that some of your transactions resulted in losses and others in gains and that some of these gains or losses were short term, while others were long term.
To determine the tax impact of your capital transactions, you must first net your short-term gains against your short term losses and your long-term gains against your long-term losses.
— If your total loss is more than $3,000 ($1,500 if married filing separately), the excess loss can be carried over to the next year.
Determine your capital gain and loss carryforwards to ensure you are aligning them to the fullest extent possible. — Consider selling assets in taxable accounts that have losses at the end of the year to offset capital gains and potentially offset $3,000 of ordinary income.
— Consult your tax adviser to determine which cost basis method optimizes your capital gains and losses. You may instruct your broker to use an alternative cost basis method or select specific tax lots to sell. In this way, you can exercise a large degree of control over your yearly short and long-term capital gains and losses.
Home Ownership
You may fully deduct mortgage interest paid on your principal residence and a second residence to the extent that (1) you use the mortgage proceeds in the acquisition, construction, or substantial improvement of the residence; and (2) the total indebtedness does not exceed $750,000 (or $1 million if the mortgage debt was incurred before December 15, 2017, or if you entered into a written binding contract before December 15, 2017, to close on the purchase of a principal residence before January 1, 2018, and you purchased the residence before April 1, 2018).
If you refinance your mortgage, you can continue to deduct the interest on the new loan, but only up to the balance of the old loan immediately before the refinancing.
You may be able to immediately deduct “points” paid on the debt you incurred in connection with the purchase or improvement of a principal residence.
When You Sell Your Residence
If you sell your principal residence at a gain, some or all of the gain may be exempt from tax. However, if you incur a loss on the sale, you may not deduct that loss.
If you and your spouse file a joint return, you can exclude a gain of up to $500,000 from the sale of your principal residence. Other taxpayers can exclude up to $250,000. The following conditions must be met:
- You must have owned and lived in the property for at least two years during the previous five years (if filing a joint return, only one spouse has to meet the ownership test).
- You must not have claimed the exclusion within the past two years. (If filing a joint return, this requirement applies to both spouses.)
Second Homes and Rental Property
Depending on its usage, property you own—such as a house, condominium, or dwelling unit—that is not your principal residence may be classified as a second residence or as rental property. The classification affects the deductibility of interest, taxes, casualty losses, and other expenses, as well as whether you have to report any rental income from the property.
You do not have to report the rental income you receive on property you used as a home if you rent it to others for fewer than 15 days a year. However, you may not take any deductions for rental expenses for that property other than mortgage interest, taxes, and casualty losses resulting from federally declared disasters.
Because the passive loss rules are so restrictive, you should consider personally using vacation rental property enough to qualify it as a second residence.
Use by a family member also generally qualifies as personal use. This approach may enable you to deduct all of the mortgage interest as qualified residence interest. Keep in mind, however, that you will forfeit deductions for the personal-use portion of other routine expenses such as repairs, maintenance, homeowner’s fees, and insurance.
Net Investment Income Tax
Individuals, estates, and trusts with income above certain thresholds are subject to an additional 3.8 percent tax—also known as the “net investment income tax” (NIIT)—on their net investment income.
Be sure to consider the tax on your net investment income when making estimated tax payments.
