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IRS Presents: 10 Facts About Capital Gains and Losses

Have you heard of capital gains and losses? If not, you may want to read up on them because they might have an impact on your tax return. The IRS wants you to know these ten facts about gains and losses and how they could affect your tax situation.

  1. Almost everything you own and use for personal purposes, pleasure or investment is a capital asset.
  2. When you sell a capital asset, the difference between the amount you sell it for and your basis – which is usually what you paid for it – is a capital gain or a capital loss.
  3. You must report all capital gains.
  4. You may deduct capital losses only on investment property, not on property held for personal use.
  5. Capital gains and losses are classified as long-term or short-term, depending on how long you hold the property before you sell it. If you hold it more than one year, your capital gain or loss is long-term. If you hold it one year or less, your capital gain or loss is short-term.
  6. If you have long-term gains in excess of your long-term losses, you have a net capital gain to the extent your net long-term capital gain is more than your net short-term capital loss, if any.
  7. The tax rates that apply to net capital gain are generally lower than the tax rates that apply to other income. For 2009, the maximum capital gains rate for most people is15%. For lower-income individuals, the rate may be 0% on some or all of the net capital gain. Special types of net capital gain can be taxed at 25% or 28%.
  8. If your capital losses exceed your capital gains, the excess can be deducted on your tax return and used to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.
  9. If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that next year.
  10. Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 13of Form 1040.

For more information about reporting capital gains and losses, see the Schedule D instructions, Publication 550, Investment Income and Expenses or Publication 17, Your Federal Income Tax. All forms and publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Links:

  • Publication 17, Your Federal Income Tax (PDF 2015.9K)
  • Publication 550, Investment Income and Expenses (PDF 516K)
  • Publication 544, Sales and Other Dispositions of Assets (PDF 321K)
  • Publication 505, Tax Withholding and Estimated Tax (PDF 367K)
  • Publication 564, Mutual Fund Distributions (PDF 178K)
  • Publication 547, Casualties, Disasters, and Thefts (PDF 133K)
  • Publication 527, Residential Rental Property (Including Rental of Vacation Homes) (PDF 187K)

Questions From Readers: Flipping Houses as a Hobby

Today I received this question from a reader about flipping houses. 

Although I’m in Missouri, there appears to be a great deal of buying of foreclosures and selling at a profit in California. The question I’ve seen asked but not answered is, “Is that a capital gains investment or a business interprise requiring the payment of self-employment tax?”

I am retired at age 65. I have long been interested in real estate and recently purchased a house as an investment/retirement activity at a foreclosure sale. To my surprise, I quickly found a buyer for it this month with a profit of about $15,000. (Our “normal” yearly income from pensions and social security is about $60,000.) I would like to continue buying, repairing and selling 2 or 3 properties a year as a profitable retirement “hobby”, but after learning that there is a risk that the IRS may consider my “flipping” a business activity that includes self-employment taxes, I am reluctant to continue.

Are you aware of any guidance from the IRS to better define this issue. Under what circumstances does the IRS decide an investment becomes a business activity?

Thanks for your input, Larry

Here is my reply

Larry
This is a complicated area. If you are engaged in this type of activity, you should hire a qualified tax professional to assist you with your tax questions.

As far as a general discussion, here are some things to consider.

Generally, flipping houses falls under a business with ordinary income aspects that would subject you to self-employment taxes. The houses that are flipped are considered inventory, which would not get capital gains treatment. What you are looking at here is really a facts and circumstances test with regard to the activity.

Whether you pay self-employment taxes is dependent on many factors such as the business entity that you will be operating from. Some entities might require that you get a W2 which will require payroll taxes be withheld. In addition, the business entity will be required to pay the appropriate employer portion of the payroll taxes. Other entities will require you to pay self-employment taxes on your income and still others may allow you to pass-through some of the income without any self-employment or payroll tax issues.

You should be aware that profitable hobbies are subject to income tax where losses from a hobby do not get you a tax deduction.

If you are looking for the rules on the tax treatment of a particular transaction, I encourage you to speak with your tax advisor before you enter into it.

I also found this interesting and helpful article by Kay Bell writen for Bankrate looks like it was picked up by Yahoo.  Check it out if you want more information. Tax Consequences of Flipping Real Estate

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