Capital gains tax in the United States

This article is about Capital gains tax in the United States. For other countries, see Capital gains tax.

In the United States, individuals and corporations pay income tax on the net total of all their capital gains just as they do on other sorts of income. Capital gains are generally taxed at a preferential rate in comparison to ordinary income (26 U.S.C. §1(h)). This is intended to provide incentives for investors to make capital investments, to fund entrepreneurial activity, and to compensate for the effect of inflation and the corporate income tax. The amount an investor is taxed depends on both his or her tax bracket, and the amount of time the investment was held before being sold. Short-term capital gains are taxed at the investor's ordinary income tax rate, and are defined as investments held for a year or less before being sold. Long-term capital gains, which apply to assets held for more than one year, are taxed at a lower rate than short-term gains. In 2003, this rate was reduced to 15%, and to 5% for individuals in the lowest two income tax brackets. The reduced 15% tax rate on qualified dividends and long term capital gains, previously scheduled to expire in 2008, was extended through 2010 as a result of the Tax Increase Prevention and Reconciliation Act of 2005 signed into law by President George W. Bush. This was extended through 2012 in legislation passed by Congress and signed by President Barack Obama on Dec 17, 2010. As a result:

• In 2008–2012, the tax rate on qualified dividends and long term capital gains is 0% for those in the 10% and 15% income tax brackets.
• After 2012, dividends will be taxed at the taxpayer's ordinary income tax rate, regardless of his or her tax bracket.
• After 2012, the long-term capital gains tax rate will be 20% (10% for taxpayers in the 15% tax bracket).
• After 2012, the qualified five-year 18% capital gains rate (8% for taxpayers in the 15% tax bracket) will be reinstated.

Capital Gains Taxation in the United States from 2003 forward

2003–2012					2013–
	2003–2007		2008–2012		2013–
Ordinary Income Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate	Ordinary Income Tax Rate	Short-term Capital Gains Tax Rate	Long-term Capital Gains Tax Rate
10%	10%	5%	10%	0%	15%	15%	10%
15%	15%	5%	15%	0%
25%	25%	15%	25%	15%	28%	28%	20%
28%	28%	15%	28%	15%	31%	31%	20%
33%	33%	15%	33%	15%	36%	36%	20%
35%	35%	15%	35%	15%	39.6%	39.6%	20%

When the taxable gain or loss resulting from the sale of an asset is calculated, its cost basis is used rather than its actual purchase price. The cost basis is an adjustment of the purchase price that takes into account factors such as fees paid (brokerage fees, certain legal fees, sales fees), taxes paid (including sales tax, excise taxes, real estate taxes, etc.), and depreciation.

History of capital gains tax in the U.S.

From 1913 to 1921, capital gains were taxed at ordinary rates, initially up to a maximum rate of 7 percent. In 1921 the Revenue Act of 1921 was introduced, allowing a tax rate of 12.5 percent gain for assets held at least two years. From 1934 to 1941, taxpayers could exclude percentages of gains that varied with the holding period: 20, 40, 60, and 70 percent of gains were excluded on assets held 1, 2, 5, and 10 years, respectively. Beginning in 1942, taxpayers could exclude 50 percent of capital gains on assets held at least six months or elect a 25 percent alternative tax rate if their ordinary tax rate exceeded 50 percent. Capital gains tax rates were significantly increased in the 1969 and 1976 Tax Reform Acts. In 1978, Congress reduced capital gains tax rates by eliminating the minimum tax on excluded gains and increasing the exclusion to 60 percent, thereby reducing the maximum rate to 28 percent. The 1981 tax rate reductions further reduced capital gains rates to a maximum of 20 percent.

The Tax Reform Act of 1986 repealed the exclusion of long-term gains, raising the maximum rate to 28 percent (33 percent for taxpayers subject to phaseouts). When the top ordinary tax rates were increased by the 1990 and 1993 budget acts, an alternative tax rate of 28 percent was provided. Effective tax rates exceeded 28 percent for many high-income taxpayers, however, because of interactions with other tax provisions. The new lower rates for 18-month and five-year assets were adopted in 1997 with the Taxpayer Relief Act of 1997. In 2001, President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001, into law as part of a $1.35 trillion tax cut program.

Tax rates for 2009

*Note: the dollar amount refers to taxable income, not adjusted gross income (AGI).

Marginal Ordinary Income Tax Rate	Single	Married Filing Jointly or Qualified Widow(er)	Married Filing Separately	Head of Household
10%	$0–$8,350	$0–$16,700	$0–$8,350	$0–$11,950
15%	$8,351– $33,950	$16,701–$67,900	$8,351–$33,950	$11,951–$45,500
25%	$33,951–$82,250	$67,901–$137,050	$33,951–$68,525	$45,501–$117,450
28%	$82,251–$171,550	$137,051–$208,850	$68,525–$104,425	$117,451–$190,200
33%	$171,551–$372,950	$208,851–$372,950	$104,426–$186,475	$190,201–$372,950
35%	$372,951+	$372,951+	$186,476+	$372,951+

Short-term capital gains are taxed as ordinary income rates as listed above. Long-term capital gains have lower rates corresponding to an individual’s marginal ordinary income tax rate, with special rates for a variety of capital goods.

Ordinary income rate	Long-term capital gain rate	Short-term capital gain rate	Long-term gain on real estate*	Long-term gain on collectibles	Long-term gain on certain small business stock
10%	0%	10%	10%	10%	10%
15%	0%	15%	15%	15%	15%
25%	15%	25%	25%	25%	25%
28%	15%	28%	25%	28%	28%
33%	15%	33%	25%	28%	28%
35%	15%	35%	25%	28%	28%

Small company stock capital gains

Section 2011 of the Small Business Jobs Act of 2010 exempts 100% of the taxes on capital gains for angel and venture capital investors on small business investments if held for 5 years. However, this exemption only applies to shares of stock. It excludes convertible debt and warrants which are major components of most angel and venture capital arrangements. This is a temporary measure that applies to stock bought after September 27, 2010 but before January 1, 2011. The temporary 100% exclusion of capital gain from the sale of certain small business stock under IRC § 1202 was extended further through 2011 by the H.R. 4853: Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 as a jobs stimulus [7] [8]. In addition, a problem with alternative minimum tax associated with the sale of company stock was fixed [9].

The President’s new budget in year 2011 will propose making permanent the elimination of capital gains taxes on key investments in small businesses, which was passed as a temporary provision in 2010 as part of the Small Business Jobs Act of 2010 the President signed in September. The budget will also propose expanding the New Markets Tax Credit Program to encourage private sector investment in startups and small businesses operating in lower-income communities. [10]

Deferring and/or reducing

Exemptions from capital gains taxes (CGT) in the United States include:

Primary residence

Under 26 U.S.C. §121 an individual can exclude up to $250,000 ($500,000 for a married couple filing jointly) of capital gains on the sale of real property if the owner used it as primary residence for two of the five years before the date of sale. The two years of residency do not have to be continuous. An individual may meet the ownership and use tests during different 2-year periods. Both tests must be satisfied during the 5-year period ending on the date of the sale. There are allowances and exceptions for military service, disability, partial residence and other reasons. The $250K ($500K married filing jointly) exemption is not increased for home ownership beyond 5 years. The $250,000 ($500,000 for a married couple filing jointly) is not available to properties bought by 1031 exchange. Capital gains on rental property can be totally avoided by using 1031 exchange. One strategy that is sometimes employed is for a homeowner to move out of the primary residence, rent it out for a period of time, evict the renters, exchange for a new house, rent the new house out, evict the new renters, and then move into the new house, thereby avoiding capital gains tax. 1031 exchange can also be used to avoid capital gains by renting out part of your principal residence.

Section 121 provides no benefit if there is a loss on the sale of the property. One is not able to deduct a loss on the sale of one's home.

According to real estate lawyer Robert Bruss, a long commute does not allow a partial exemption in tax to move closer to work. In an article in the Washington Post, Bruss pointed out that bankruptcy of your present employer would likely permit a homeowner a partial use of the $250K / $500K exemption to allow a homeowner to move to a new job in a different city. According to an article in the Washington Post, a taxpayer can move more often to avoid capital gains tax in expensive areas.

Capital losses

If an individual or corporation realizes both capital gains and capital losses in the same year, the losses (except losses from the sale of personal property including a residence) cancel out the gains in the calculation of taxable gains. For this reason, toward the end of each calendar year, there is a tendency for many investors to sell their investments that have lost value. For individuals, if losses exceed gains in a year, the losses can be claimed as a tax deduction against ordinary income, up to $3,000 per year ($1,500 in the case of a married individual filing separately). Any additional net capital loss of the individual can be "carried over" into the next year and "netted out" against gains for that year. Corporations are permitted to carry any size capital loss back three years to off-set capital gains from prior years, thus earning a kind of retroactive refund of capital gains taxes. After the carryback, a corporation may carry the unused portion of the loss forward five years.

Deferment strategies

Capital gains tax can be deferred or reduced if a seller uses the proper sales method and/or deferral technique. The IRS allows for individuals to defer capital gains taxes with tax planning strategies such as the structured sale (ensured installment sale), charitable trust (CRT), installment sale, private annuity trust (no longer valid), and a 1031 exchange.

• Deferred sales trust – Allows the seller of property to defer capital gains tax due at the time of sale over a period of time.
• 1031 exchange – Defer tax by exchanging for "like kind" property. Capital gains can be deferred forever by buying a replacement real estate by a business, but not for personal real estate.
• Structured sale annuity (aka Ensured Installment Sale) – Defer and reduce capital gains tax while gaining safety and a stream of guaranteed income.
• Charitable trust – Defer and reduce capital gains by giving equity to a charity.
• Self directed installment sale (SDIS) – Allows for the deferral of capital gains taxes while removing the risks from buyer default under a traditional installment sale.

See also

• Withholding_tax#International_withholding

External links

• IRS "Like Kind Exchanges Tax Tips"