You don’t have to be rich to care about capital gains

With apps like OfferUp, Letgo, and Poshmark—not to mention stock trading apps like Acorns—it’s easier than ever to sell things you own, which the IRS considers capital assets. If you sell an item for more than you paid for it, you might have to pay a capital gain tax on the profit. That applies not only to real estate and stocks, but also to books, paintings, vintage clothing, electronics, or anything else you sell for a profit.

For tax purposes, generally, the cost of an item is known as your "basis" in the item. Your basis includes the price of an item plus any additional costs you paid to acquire it. These additional costs may include:

  • Taxes, including sales tax, excise taxes, VAT, and all other levies and fees
  • Delivery costs and handling fees
  • Charges for installation

The cost of improvements that end up increasing the value of an asset—such as money spent restoring a classic car or refurbishing an antique piano—often can be added to the basis. By contrast, the depreciation of your asset usually reduces the basis.

Here are three more things to keep in mind about capital gains.

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1. The duration of your ownership is important

The size of a capital gains tax can depend on the length of time you owned an asset before you sold it. Most often, when you sell an asset within a year of acquiring it, any increase in its value is considered a "short-term" capital gain. When you sell an asset more than one year after acquiring it, the increase in value is typically a "long-term" capital gain.

  • The tax on a short-term capital gain can be 10-20% or more than the tax on a long-term capital gain.
  • The difference in tax rates between long- and short-term capital gains treatment is one advantage the "buy-and-hold" method of investing has over frequent trading.

The rate difference between short- and long-term capital gains can literally mean the difference between taxes and no taxes. Many people who are in low tax brackets aren’t required to pay capital gains tax on their long-term gains. However, they may be taxed on their short-term gains.

2. A carve-out for homeowners

Home ownership offers many possible benefits—security from rent increases, a major tax deduction for mortgage interest, and the potential for a large capital gain if a homeowner sells the house in a hot real estate market. Fortunately, a carve-out in the tax code provides an exemption for homeowners, provided you meet certain conditions (certain exceptions apply). They include:

  • You owned it for at least two years.
  • The home was your primary residence for at least two of the last five years.
  • In the two years prior to the sale, you did not exclude the capital gain from the sale of another home.

When you’re able to meet all three conditions, you normally can exclude up to $250,000 of the capital gain if you file your income taxes as single and exclude up to $500,000 if you file married filing jointly.

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3. Investment losses that reduce capital gains

No one likes to lose money, but some losses can lead to tax savings. When you sell investments such as stocks or bonds for less than their basis, you experience a capital loss that can often be used to offset capital gains. However, capital losses from the sale of personal property cannot be used to reduce your capital gains.

Example: You enjoy a $40,000 long-term capital gain from the sales of stocks, but you experience a $20,000 long-term loss from the sales of other stocks. As a result, you most likely will be taxed on only $20,000 of your long-term capital gains.

  • $40,000 in capital gains - $20,000 in investment losses = $20,000 in long-term capital gains

There may be times when you have losses but few or no capital gains you need to offset. When your capital losses are greater than your capital gains, you might be able to use your capital losses to offset up to $3,000 of your other income. If your capital losses exceed $3,000, you can typically carry the excess amount forward to offset capital gains or up to $3,000 of income in future years.

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