Ch6. Capital Gains Tax — Tax on Selling Real Estate and Securities

What Is Capital Gains Tax?

Capital gain: The profit from selling or exchanging a capital asset — property held for investment or personal use.

Taxable capital assets include:

Real estate (land, buildings, rental property)
Stocks, bonds, mutual funds, ETFs
Business interests (partnership interests, S-corp stock)
Collectibles (art, coins, wine)
Cryptocurrency (treated as property by the IRS)

Capital Gains Tax Computation

Amount Realized (selling price + any liabilities assumed by buyer)
  − Adjusted Basis (original cost + improvements − depreciation taken)
= Gain Realized
  − Any exclusions (e.g., § 121 home sale exclusion)
= Gain Recognized
  (Classified as short-term or long-term based on holding period)
  × Applicable Tax Rate
= Capital Gains Tax

Adjusted Basis: Usually the original purchase price, plus costs of improvements, minus any depreciation deductions previously claimed.

Federal Capital Gains Tax Rates

Short-Term Capital Gains (Held 12 months or less)

Taxed at ordinary income tax rates (10%–37%) — the same rates as wages and salary.

Long-Term Capital Gains (Held more than 12 months)

Preferential rates based on taxable income (2024, single filer):

Taxable Income	Long-Term Rate
$0 –$ 47,025	0%
$47,026 –$ 518,900	15%
Over $518,900	20%

Married Filing Jointly thresholds are approximately double (0% up to $94,050; 20% over$ 583,750).

Collectibles and Section 1250 unrecaptured depreciation: Subject to a maximum rate of 28% and 25%, respectively.

Net Investment Income Tax (NIIT): An additional 3.8% applies to net investment income (including capital gains) when AGI exceeds $200,000 (single) /$ 250,000 (MFJ).

Section 121 — Home Sale Exclusion

The most powerful US tax benefit for homeowners: a large exclusion from capital gains on the sale of a primary residence.

Exclusion Requirements

§ 121 Exclusion:
1. The property must be the taxpayer's principal residence
2. Taxpayer must have owned the home for at least 2 of the last 5 years
3. Taxpayer must have USED (lived in) the home for at least 2 of the last 5 years
   (ownership and use need not be concurrent)
4. Exclusion not used in the prior 2 years

Exclusion amount:
- Single / Married Filing Separately: up to $250,000 of gain excluded
- Married Filing Jointly: up to $500,000 of gain excluded

Gain above the exclusion: taxed as long-term capital gain
(if § 121 use and ownership requirements are met, the entire gain
up to the limit is excluded regardless of the home's value)

Special Cases

Partial exclusion: If you sell before meeting the 2-year requirements due to job change, health issues, or unforeseen circumstances, you may exclude a pro-rated amount
Vacation/rental homes: The § 121 exclusion does not apply to vacation homes or investment properties not used as a primary residence
Home previously used as rental: A portion of the gain equal to post-2008 rental use periods may not qualify for the exclusion (“non-qualifying use” rules)

Long-Term Capital Gains Holding Period Strategy

Holding a capital asset for more than 12 months converts short-term gains (taxed as ordinary income, up to 37%) to long-term gains (15% or 20%):

Illustrative Tax Savings

Example: $100,000 gain from selling stock

Short-term (< 12 months), 37% bracket:
$100,000 × 37% = $37,000 tax

Long-term (> 12 months), 20% bracket:
$100,000 × 20% = $20,000 tax

Tax savings from holding one extra day past the 12-month mark: $17,000

Multi-Home Ownership Tax Issues

No § 121 Exclusion for Investment Property

Investment and rental properties are not eligible for the § 121 exclusion. Gain is fully taxable (long-term rates apply if held 12+ months).

1031 Like-Kind Exchange (Investment Real Estate)

For investment and business real estate, a § 1031 exchange allows deferring capital gains tax by rolling the proceeds into a “like-kind” replacement property:

§ 1031 Exchange rules:
- Both properties must be held for investment or business use
- Must identify replacement property within 45 days of sale
- Must close on replacement property within 180 days of sale
- All equity must roll over (any "boot" received is taxable)
- Gain is deferred (not forgiven) — basis carries over

This is one of the most powerful real estate tax deferral strategies available.

Stock and Securities Capital Gains

Listed Securities

Long-term gain (12+ month holding): 0%, 15%, or 20% rates
Short-term: ordinary income rates
Annual capital gains from stocks reported on Schedule D of Form 1040

Wash Sale Rule (IRC § 1091)

A loss on a security sale is disallowed if you buy the same or substantially identical security within 30 days before or after the sale:

Wash sale example:
Dec 20: Sell 100 shares of XYZ at a $5,000 loss
Jan 5 (16 days later): Buy 100 shares of XYZ

→ The $5,000 loss is DISALLOWED under the wash sale rule
→ The disallowed loss is added to the basis of the new shares

Cryptocurrency

The IRS treats crypto as property (Notice 2014-21). Every crypto sale, exchange, or use is a taxable event:

Gains are short-term (ordinary rates) or long-term (preferential rates) based on holding period
Mining and staking income is ordinary income at fair market value when received

Capital Gains Tax Filing

Schedule D (Form 1040): Reports all capital gains and losses. Form 8949: Itemizes individual sales transactions.

Reporting deadline: Annual — included with Form 1040 by April 15. Estimated taxes: If large capital gains are expected, increase quarterly estimated payments to avoid underpayment penalties.

Capital Gains Tax Planning Points

1. Maximize holding periods The biggest lever: hold assets for 12+ months to qualify for long-term rates, and consider 10+ years to capture maximum appreciation with a low tax rate.

2. Maximize the § 121 exclusion Ensure you meet the 2-year ownership and use requirements before selling a primary home. For a married couple, this can exclude up to $500,000 of gain.

3. Include all deductible costs in your basis Purchase-related costs (title fees, legal fees, transfer taxes), capital improvements, and selling costs (agent commissions, transfer taxes, legal fees) all reduce your taxable gain.

4. Spread dispositions across tax years Selling multiple appreciated assets in a single year can push you into higher brackets. Consider spreading sales across two or more calendar years.

5. Tax-loss harvesting Capital losses can offset capital gains dollar-for-dollar. Net capital losses of up to $3,000 per year can be deducted against ordinary income; excess losses carry forward indefinitely.

Learning Checklist

Walk through the capital gain computation from amount realized to tax due
State the three requirements for the § 121 home sale exclusion
Explain the long-term vs. short-term capital gains rate distinction and when it applies
Describe the § 1031 like-kind exchange and its key timing rules
Explain the wash sale rule and its effect on loss recognition

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