Capital gains are profits from the sale of an asset—a business, your home, personal property,  shares of stock, and more. Capital gains are considered taxable income. How much tax you pay depends on how long you held the asset. Capital gains are either short-term or long-term. Long-term capital gains are taxed at lower rates than short-term capital gains, which are taxed as ordinary income.

Short-Term Capital Gains Tax

Assets held and sold in less than one year are considered short-term capital gains. The tax you pay equals your income tax bracket.

Long-Term Capital Gains Tax

In 2019, the IRS announced adjustments in long-term capital gains tax brackets due to inflation. Long-term capital gains are taxed on assets that are held for more than one year. The tax rate depends on your filing status and taxable income. The capital gains tax is  0%, 15%, or 20%, which is lower than short-term capital gains tax.  

How Do You Calculate Capital Gains Tax Rate?

Short-term capital gains are taxed as ordinary income. How much you pay depends on your filing status—single, married, filing jointly, married filing separately, etc.— and your income tax bracket.

Long-term capital gains are taxed differently. For instance, if you’re head of household and your income is between $53,601 and $469,050, your long-term capital gains tax rate will be 15%. Also, some types of sales, like collectibles or real estate, may be taxed at different rates.

To calculate your long-term capital gains tax:

1. Figure out your basis. The basis is the purchase price, plus any fees or commissions you paid, reinvestments on stocks, and other factors.
2. Determine the sale price minus any fees or commissions. This is called the realized amount.
3. Subtract what you paid (your basis) from how much you sold it for (your realized amount) to find the difference.
4. If you sold your asset for less than you paid, it’s a capital loss.
5. If you sold your asset for more than you paid, it’s a capital gain.
6. Determine your tax rate to apply to your capital gains.

Is Real Estate Income Considered Capital Gains?

If you’ve held real estate as an investment, you will be taxed on the profit you make from the sale. How much tax you pay depends on how long you’ve held the property and whether it’s a home or another type of real estate. Unlike other investments, stocks, for instance, profits from selling your home fall under a tax-free capital gains exemption by the IRS. You might qualify, but there are requirements you need to meet.

No matter your income, the IRS allows a $250,000 tax-free exemption on capital gains from the sale (and profit) of your primary residence—for each person. So, if you and your wife (married, filing jointly) buy a home for $200,000 and sell it many years later for $600,000, you won’t owe any tax on your capital gains. (You showed a profit of $400,000, but both you and your wife can claim $250,000). And, this capital gain is excluded from your income permanently.

To claim this capital gains exemption, you will need to meet certain requirements.

• You must have owned your home for at least two years and used it as your primary residence.
• You must have lived in your home for no less than two years out of the past five years.
• You cannot have taken this tax-free exclusion in the past two years.

Although you may not meet these tax-free exemptions, you still may be able to claim a partial exclusion. For instance, if your job transfers you to another town or you're in the military, and you're called up for active duty in another country before you’ve lived in your home for two years, you may qualify for a partial exclusion. For more information, check out IRS Publication 523.

Unfortunately, a capital loss on the sale of your home that you used as your primary residence at the time of the sale isn’t deductible on your taxes. Only real estate losses used in a trade or a business and investment property—like stocks—are deductible.

Can I Avoid Paying Capital Gains on My Real Estate Investment?

If you're selling a home that you don’t use as your primary residence, maybe you rented it out or flipped it, you may be able to avoid paying capital gains on the sale. It’s complicated but possible. You can do this by exchanging “like-kind” properties using a 1031 exchange, which lets you sell one property and buy another one without claiming any gain in the tax year of the sale. However, there are strict IRS rules and guidelines that may exclude these transactions, so read up first.

Can Home Improvements Help Reduce Capital Gains Tax?

Yes. You can reduce the amount of capital gains you’ll pay if you’ve made home improvements on your primary residence. For instance, if you finished the basement, added a new roof, or replaced your deck, you can add those costs to the initial price of your home, which will give you an adjusted cost basis. The higher your adjusted cost basis, the lower your capital gain when you sell the home.

For example, you purchased your home for $100,000 and sold it for $400,000, 15 years later. In that time, you spent $50,000 on home improvements, which you can subtract from the sale price of your home in the year you sold it. Instead of owing capital gains taxes on the $300,000 profit from the sale, you would owe taxes on $250,000. However, when you figure in the $250,000 tax-free exemption on capital gains, you’d owe nothing.

Other Capital Gains Rules and Exceptions

The IRS capital gains tax rules apply to most assets. However, three are a few exceptions:

• Long-term capital gains on collectibles, like old coins, artwork, and antiques, are taxed at a rate of 28%.
• You cannot claim a deduction for capital losses from the sale of personal property. So if you sell your home for less than you paid for it, you cannot claim a deduction.
• When you inherit a capital asset, like a home or car, it is considered a long-term capital investment no matter when the person who left it to you purchased it.
• If your home was damaged, condemned, or destroyed, you, your spouse or other co-owner divorced, passed away, or there was an unforeseeable event identified by the IRS in the year when you sell your home, you may qualify for a partial exception from capital gains.
• If you, your spouse, or other co-owner had to move to provide care to a family member due to doctor orders, you might also claim a partial exemption.
• If you sell property-like a home-that is located outside of the U.S., you must also report capital gains from the sale (unless the property is exempt by U.S. law).

How to File Capital Gains Tax?

Nearly everything you own and use for personal, pleasure, business, or investment purposes is a capital asset, including:

• Your home and household furnishings
• Business property, furnishings, and equipment
• Coin or stamp collection
• Stocks or bonds
• Jewelry and gems
• Gold, silver, or any other metal

So when you sell a capital asset and make a profit from the sale, you’ll pay capital gains tax. You report both capital gains and deductible capital losses on Form 1040, Schedule D, on your Individual Income Tax Return.

If you normally make estimated tax payments and have a taxable capital gain, you will want to refer to Publication 505 PDF for additional information on how to file.

What if You Own a Second Home?

In most instances, a second home is defined as a property that is your primary residence for part of the year. It cannot be a primarily rental property. For example, If you own a property that you live in for six months during the winter and rent out for two months every summer, it is generally considered a second home. Plus, you can own more than one “second home.”

However, since a “second home” doesn’t meet the definition of a primary residence by the IRS, you cannot claim the capital gains exemption. So, if you sell your second home, you are taxed on the capital gains (profit) from the sale of the home at the appropriate tax rate.  

What if You Rent Out Your Home?

Let’s say you buy a condo. You live in it for the first year, then decide to rent it for the next three years. But after your tenants move out, you move back in for another year. At the end of the five-years, you can sell your condo and not pay capital gains tax.

Paying (or not paying) capital gains is a bit tricky, so it pays to know the difference between short-term and long-term capital gains, tax rates, the rules and exceptions, and your overall tax implications. Understanding capital gains may also help you make better investment decisions that can help during tax season.