How do you measure gain or loss for tax purposes?
UPDATED: February 26, 2013
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Capital gain is defined as the difference between the cost to purchase the property and the sale price. The initial price paid for the property is known as basis. Cost of improvements to the property can be included when calculating the property’s basis. Any selling expenses can also be deducted from the proceeds of the sale, which reduces the amount of capital gain.
If property is sold at a loss, meaning that it sells for less than it was purchased for, that is then known as a capital loss. The amount realized is the final amount the seller receives after all costs and expenses have been subtracted from the sale proceeds.
The amount of time a taxpayer has owned the property before selling it impacts the tax treatment of the proceeds from the sale. If the property is owned for more than one year before it is sold, the amount realized from the sale will be classified as long-term capital gain. Property owned for less than one year and then sold is classified as a short-term capital gain.
Long-term or short-term gain is taxed at different rates. Short term gain is taxed at ordinary income tax rates. The long term capital gains tax rate for 2011 and 2012 is either 0% or 15% depending on your overall income from all sources, and there are some rare cases where the capital gains tax rate can be 25% or 28%. Starting in 2013, the rate rises to 20%, but kicks in only for high income taxpayers earning more than $400,000 for single and $450,000 for married filing jointly.
Also beginning in 2013, as part of the Affordable Care Act, a new 3.8% Medicare surtax is imposed on the lesser of "net investment income" or adjusted gross income in excess of $200,000 ($250,000 if married filing jointly). Net investment income includes short- and long-term capital gains as well as other annutiy income, royalties,rents and other income items.
Stock Sales: Lisa purchased 100 shares of ABC stock in December of 2005. Her cost per share was $10.00. In 2007 the stock split giving her 200 shares at cost of $5.00 per share. When a stock splits, your cost per share is recalculated. In 2011 the stock is worth $12.00 per share. Lisa chooses to sell 75 shares. The brokerage firm she uses charges a 2% commission on the sale. The stock sale grosses $900.00. She pays commission of $18.00 on the sale, and has realized proceeds of $882.00. Her original cost in the 75 shares is at $5 per share or $375.00 giving her a long term capital gain of $507.00, since she held the stock longer than a year.
Real Estate: Bob purchases an investment home in 2000 which he uses as a rental property. He paid $100,000.00 for the property. He deducts straight line depreciation of $3,636.00 on his Schedule E as a rental expense for 10 years, for a total depreciation of $36,360. In 2010 he decides to sell the property because he no longer can afford the mortgage and the bottom has dropped out of the housing market. He sells the property for $80,000.00. He has selling expenses of $8,500.00 giving him a realized amount of $71,500.00. This gives him a capital gain of $28,500.00. However, Bob has to recapture 10 years worth of depreciation for a total of $36,360. This leaves him a net gain of $7,860.00 which must be taxed at ordinary tax rates.