With legislation now in place to avert the fiscal cliff many investors will be breathing a sigh of relief as the tax rates on capital gains, dividends on investments did not rise as much as expected. However under the fiscal cliff deal investment income will still be taxed at 15 percent. Higher income earners, those making more than $400,000 ($450,000 for couples), will however pay 20 percent. This does not include the 3.8 percent health care surtax which also applies to investment income for higher income earners.
What is a Capital Gain or Loss? When you sell a capital asset like a stock or a home you own, the difference between the amount you sell it for and what you paid for it (cost basis) is classified as a capital gain or a capital loss. Capital gains and losses are further classified as long-term or short-term, depending on how long you held the investment before you sold it. If you have held the asset more than one year, your capital gain or loss is classified as long-term. If you held the asset for one year or less, your capital gain or loss is considered short-term. Based on the duration of asset ownership and the tax filers personal tax rate, we can calculate their capital gains tax rate. For 2012 this is shown in the table below. In 2013, the rates wills stay the same, expect for those earning more than $400,000 ($450,000 for couples) who will face a 20% rate for long term gains. Short term gains will be taxed at 2013 marginal tax rates levels.
Short-term capital gains are taxed like ordinary income at tax rates up to 35% for 2012 (and 39,6% in 2013). For example if Julia bought shares in Apple (AAPL) in February 2012 and sold them in November 2012, her gain or loss on the investment will be classified as short-term.
Long-term capital gains (assets held for more than one year) are taxed at 0% for taxpayers in the 10% and 15% tax brackets and 15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets. The 0% tax rates for those in the 10% and 15% federal income tax brackets was a special provision in the bush-era tax cuts which were extended to 2013.
If your capital losses are more than your capital gains, you can claim a capital loss deduction in your tax filing. Your allowable deduction is $3,000 ($1,500 if you are married and filing separately) and can be claimed against your ordinary income. There are various exceptions and special provisions when it comes to the treatment of capital gains or losses and you should consult IRS Publications 17 and 550 for more details.