Preparing Income Taxes - 2 Ways Capital Assets Save You Money

What is a capital asset? Tax authorities like the Internal Revenue Service and state taxing authorities expect you to report any capital gains or losses on your annual income tax return. This information is reported on IRS Form 1040, Schedule D, Capital Gains and Losses and then transferred as a "cumulative" net amount to Line 13 in the income section on the top page of your IRS Form 1040. You can't file an income tax return that has capital gains or losses using IRS Form 1040A if you are required to file Schedule D to report the income.

Why should you care what is or is not a capital asset? It is important because it could save you money! Tax rates applied to capital gains income are often significantly lower than a person's marginal income tax rates. In other words, you often owe less tax if you sell a capital asset! For 2009 and 2010, a taxpayer in the 15% marginal income tax bracket will pay 0% on any net capital gains! But there is yet another way it can save you money.

The second way you can save money is if your capital loss is greater than your capital gains for the tax year. If gains are less than your losses, you have a cumulative or net loss. This means you can deduct up to $3000 ($1,500 if you are married but filing separately) from your income tax. If the loss is greater than this annual limit, you can "carry forward" the unused loss into future years until it is all used up. There is a catch, though. You can deduct a capital loss only on investment property; you can't deduct a capital loss on personal use property. This distinction is important; you typically don't own investment property, according to IRS code, for personal enjoyment! It is also important to remember that if you anticipate a significantly large taxable capital gain during the year, you are required to make estimate tax payments (even though it will be taxed at a preferentially lower rate).

Your understanding of the definition of a capital asset and how you dispose of it is an important part of managing your personal finances. More information is available in IRS Publication 544, Sales and Other Dispositions of Assets or on the IRS website, IRS.gov. Knowing the "rules" about capital assets could save you lots of cash AND grief.