The Difference Between Capital Gains and Ordinary Income

Most long-term capital gains are taxed at 15% for 2010. This rate is scheduled to increase to 20% in 2011. Unfortunately, we need to say "most" because there are some exceptions as follows:

Taxpayers in the 10% and 15% ordinary bracket-0%
Certain depreciation recapture on real estate-25%
Collectibles-28%

A long-term gain is from the sale of a capital asset held longer than a year. A capital asset includes stocks, bonds, mutual funds, and real estate (other than residence).

Short-term gains are those that are held one year or less. Short-term gains are taxed at ordinary income tax rates. Ordinary income tax brackets for married couples filing joint for 2010 are projected as follows:

Taxable Income Tax Rate

0€-16,750 - 10%
16,750€-68,000 - 15%
68,000€-137,300 - 25%
137,300€-209,250 - 28%
209,250€-373,650 - 33%
Over 373,650 - 35%

The highest ordinary income tax bracket is also scheduled to increase in 2011 to 39.6%.

Capital gains and losses are netted against each other. If this results in a net loss, this loss is limited to a $3,000 tax deduction for a married couple filing a joint return. Any loss above this is carried into future years.

However, be cautious. Some taxpayers may be subject to an Alternative Minimum Tax ("AMT"). Taxpayers need to calculate their income two ways. First, calculate the income tax under the regular method, and second, under the AMT method. Then pay the higher of the two taxes. For taxpayers subject to the AMT, it may make their effective tax rate on long-term capital gains higher than the stated rate of 15%.

It is important to know the holding period for any capital assets and whether the sale will result in a gain or loss.

Thomas F. Scanlon, CPA, CFP.

Special Tax Rules on the Sale of Your Home

If you sell your home the IRS rules permit you to exclude up to $500,000 of the gain ($250,000 if you are single) on the sale. In order to qualify for this exclusion you must have owned and used your home at least two years out of a five-year period ending on the date of the sale (known as ownership & use tests). The best part about this gain exclusion rule is that it is not a one-time exclusion. You can exclude gains on subsequent sales as well, as long as you meet the ownership and use tests.

Special rules regarding the capital gain exclusion:

1. Death of Spouse - As long as the sale of your home occurs within two years of your spouse's death, you are eligible for the gain exclusion.
2. Nursing Homes - If you are admitted to a licensed care facility (e.g. nursing home) the use test is relaxed and the time spent in the nursing home will be considered as time spent in your home.
3. Divorce - In order for the divorced spouse not residing in the home, to be eligible for the gain exclusion, the divorce degree must stipulate that the former spouse living in the home, was granted use of the property pursuant to the divorce agreement. If the divorce agreement does not include this provision, then the former spouse, may fail the use test and become ineligible for the gain exclusion.
4. Job Relocation - The rule permits a reduced gain exclusion when the ownership/use tests are not met due to a job exclusion. The gain excluded is prorated based on the number of days of ownership or use divided by 730 days.
5. Rental of a Portion of Your Home - The entire gain may be excluded, however, a portion of the gain attributable to post May 6, 1997 depreciation is subject to a maximum 25% tax rate. This exclusion rule does not apply to two-family homes. In such case only the unit used as a home qualifies.