How Capital Gains Tax Works

Taxable Gains

If you sell your house and make a profit from the sale, that qualifies as a capital gain.
If you sell your house and make a profit from the sale, that qualifies as a capital gain.
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The IRS defines a capital asset as "almost everything you own and use for personal or investment purposes" [source: IRS]. That's a lot of stuff. So technically, yes, you'd have to tell the IRS about that Bee Gees record. But the most common taxable assets are securities, real estate and valuable collectibles.

Securities are any kind of financial instrument or investment contract that has value. Examples are stocks, bonds and options. Once again, it's important to understand that you'll only be taxed on securities that you've sold in the past year. If your stocks go up during the year, but you hold on to them, you won't be charged a capital gains tax. Other types of investment income that fall into the capital gains category include annual dividends received from certain types of mutual funds and real estate investment trusts (REITs).

If you use a broker to help buy and sell stocks and bonds, then the brokerage firm will send you a form at the beginning of the year called a "1099-B, Proceeds From Broker and Barter Exchange Transactions," which lists all of your earnings and losses from the sale of securities. It's typical for the brokerage firm to list the earnings as net proceeds, meaning how much you earned minus any associated commissions and fees. If they list gross proceeds, then you'll have to deduct the commissions and fees yourself [source: CCH].

If you sell real estate or property, either for personal or business purposes, and make a profit from the sale, then that qualifies as a capital gain. Different tax rates apply to sales of personal and business property. Thanks to the Taxpayer Relief Act of 1997, however, there are some significant tax breaks when you sell your primary residence.

According to the 1997 law, if you've used a home (or apartment, or trailer or even houseboat) as your primary residence for at least two out of the last five years, you can exclude up to $500,000 in capital gains from the sale of that property [source: Investopedia]. The $500,000 exclusion is only for married couples who file jointly. Individual filers can exclude up to $250,000. That means you don't have to pay taxes on money made from selling a primary residence unless the earnings exceed $250,000 or $500,000, depending on your filing status.

Sales of art, rugs, antiques, jewelry, precious metals, wine, stamps, coins and other valuable collectibles are indeed taxable as capital gains. We'll talk more about capital gains tax rates and how to calculate them in the next section.