What are capital assets?
Nearly everything owned by taxpayers is considered a capital asset. It doesn’t matter whether the taxpayer uses the property for personal or investment purposes. The most common capital asset owned by U.S. taxpayers is their primary residence. Other examples of capital assets include household furnishings, stocks and bonds held in a personal account, cars, coin or stamp collections, jewelry, gold or any other type of precious metal.
Tax Consequences for Capital Assets and Exclusions
Whether property is considered a capital asset (and how much it sells for) is important because it triggers certain tax consequences. Examples of assets that are not considered capital assets include copyrights, artistic compositions created by the taxpayer, literature written by the taxpayer, music composed by the taxpayer, and any type of property used in a taxpayer’s trade or business.
Taxpayers can choose to classify musical compositions as capital assets if they decided to sell them. The most common type of asset that is not considered a capital asset is property owned by the taxpayer for sale as part of merchandise in the taxpayer’s business. Although gold, silver, stamps, coins, and gems are usually considered capital assets, when they are owned by a dealer in the course of business, they will not be classified as capital assets. Supplies used by a taxpayer in the course of business are also not considered capital assets. If the capital asset was received as a gift or inheritance, the tax treatment will be different from capital assets purchased by taxpayers.
Capital Assets and Capital Gain
When a capital asset is sold for a profit, the difference between the cost to purchase the asset and the sale price is classified as capital gain. Profits or gains from the sale of a capital asset are taxed at a lower tax rate than regular income tax rates. However, there are some exceptions to this rule. Most notably, gains from selling collectibles, such as coins or art, and gains from selling qualified small business stock are taxed at 28 percent. If the asset is sold at a loss, meaning that the owner sold the asset for an amount lower than it was purchased for, the taxpayer is considered to have a capital loss.
Capital Loss and Tax Deductions
If you incur a loss from the sale of personal use property such as your home or car, that loss is not deductible on your tax return. Losses from the sale of other capital assets are deductible up to a certain limit. If the loss from the sale of a capital asset exceeds the gain, married taxpayers can deduct that amount if it is less than $3,000. Single taxpayers can deduct up to $1,500.
Losses exceeding the limit can be carried forward to the next tax year. For example, Anne purchased stock for $10,000. Assume she sold it for $4,000, giving her a loss of $6,000. This means that Anne can deduct only $3,000 that year because that is the maximum limit allowed by the IRS. However, Anne still has $3,000 more of loss, so she can carry it forward and deduct that on her taxes the following year.
Capital Asset Long-Term, Short-Term Tax Treatment
How long a taxpayer owns a capital asset before selling it also affects the tax treatment of the proceeds from the sale. If a capital asset is owned for more than one year before it is sold, the proceeds from the sale will be classified as long-term. If the capital asset is owned for less than a year before it is sold, the proceeds from the sale will be classified as a short-term. Profits from the sale of long-term or short-term assets are taxed at different rates.
Taxpayers considering the sale of capital assets should consider whether the sale of a capital asset is appropriate for their situation and what tax consequences will result from the sale. Consider contacting a tax attorney for help.