Income earned from the sale of property is usually taxable. Losses are deductible for investment and business property, but not for personal property. There are many rules that govern how property sales are taxed, depending on whether the property is personal, investment, or business property, and whether the property is considered a capital asset.
Sales of capital assets are subject to ordinary income tax if the property was not held longer than 1 year; otherwise, a more favorable long-term capital gains tax will apply to the sale. However, many types of property are not considered to be a capital assets, including business inventory, and assets created through one's efforts, such as copyrights and patents.
This article presents an overview on the taxation of property sales, but more detailed information and examples can be found in the links to the other articles.
Net profit from property sales is calculated by subtracting your tax basis from the net sales proceeds, the sales price minus selling costs. The tax basis equals the purchase price plus any costs in buying the property. So, for instance, if you use a discount broker that charges $4 per trade, and you by $100 worth of securities, then later sell the same securities for $200, then add the $4 commission to your purchase price to figure basis and subtract $4 from the selling price to figure your net sales proceeds; your net profit would be $196 – $104 = $92. If the property was depreciated, then the depreciation is recaptured and may be subject to a different tax rate.
Taxable Gain or Deductible Loss = Net Sales Proceeds – Tax Basis
Most investment property, such as stocks and bonds, are capital assets, so their sale or other disposition will result in a capital gain or loss. However, business inventory and property held for sale to customers are not capital assets; likewise, for depreciable business and rental property, although a portion of the gain of depreciable business property may be treated as a capital gain under IRC §1231. Property that was created by your own efforts, such as copyrights on works written by you, or received as a gift from someone who created the property is not treated as a capital asset and is subject to ordinary income tax rates. An exception exists for the sale of musical compositions and copyrights of musical works that you created by electing on Form 8949 to treat the sale as a sale of a capital asset.
The tax rate applicable to capital assets depends on the holding period. If the asset was held 1 year or less, then it is subject to ordinary income tax rates; if held longer than 1 year, then the tax rate will be the lower of the ordinary rate or 0%, 15%, 20%, 25%, or 28%, depending on the type of property and on the income of the taxpayer. Taxpayers in the lowest 2 tax brackets do not have to pay any tax on long-term capital gains for those assets that are not subject to the 25% or 28% rate, while those in the highest tax bracket pay the 20% rate.
The 25% rate applies to the recaptured depreciation of real estate and the 28% rate applies to collectibles — antiques, art, coins, gems, precious metals, and stamps — and on unrecaptured §1250 gains from the sale of real estate or on the sale certain small or Empowerment Zone business stock. The 28% gain can be reduced by any losses on collectibles, short-term capital losses, and any long-term capital loss carryover from the previous year, figured on Part II of Form 8949. Unrecaptured §1250 gain is the portion of gain attributable to any post-1986 depreciation, figured in the Schedule D instructions; any recaptured depreciation before 1987 is taxed at ordinary income tax rates. A net loss from the 28% rate group reduces the §1250 gain.
Long-term capital gains are reported by mutual funds on Form 1099-DIV, Dividends and Distributions, by partnerships on Schedule K-1, Partner's Share of Income, Deductions, Credits, etc., by S corporations on Form K-1 (Form 1120S), Shareholder's Share of Income, Deductions, Credits, etc., and by estates and trusts on Schedule K-1, Beneficiary's Share of Income, Deductions, Credits, etc.
These tax rates only apply if the ordinary income tax rate of the taxpayer is higher; otherwise, the lower ordinary rate applies. Note, however, that investment income received by children may be subject to the kiddie tax, in which case, the applicable tax rate of the parent with the highest income will apply.
The capital gains rates are figured on Qualified Dividends and Capital Gain Tax Worksheet in Form 1040 instructions, which is also used to net, or combine, short- and long-term capital gains and losses. The 28% gain on recaptured §1250 gain is figured on Schedule D Tax Workshop Worksheet in the Schedule D instructions.
Like-kind exchanges of business or investment property can defer tax until the sale of the exchanged property. If the property owner dies before selling the property, then the gain will never be taxed since the beneficiary of the property will receive a stepped-up basis equal to the fair market value of the property when the decedent died.
If you sell company stock back to your employer, where a portion of the sale price is attributable to a covenant not to compete with the employer for a specified time, then that portion is subject to ordinary income tax and is not considered a capital gain.
Capital Losses and Carryovers
Losses from the sale personal property are not deductible. Losses from the sale of capital assets are deductible from any capital gains and up to $3000 ($1500 if married filing separately) of other income annually. If the you die, then any losses on your property or carryover losses exceeding $3000 cannot be deducted by your estate nor can they be carried over or deducted by your surviving spouse, even on a joint return. If a married couple filed separately previously, but file a joint return, then carryover losses from each spouse can be combined; if the coupled file jointly previously, but decided to file separately, then any carryover losses can only be deducted by the spouse who incurred the loss.
Losses from the sale of property between related parties, including between blood relatives and half relatives, between businesses where the taxpayer has a majority interest in both, between a trust and grantor or beneficiary. Business ownership includes the interest held not only by you, but also by family members, any partner in your partnership, and the proportionate share of any stock held by a corporation, partnership, estate, or trust where you are a shareholder, partner, or beneficiary. However, if the related-party sells the property at a profit, then the disallowed loss is added back to the basis of the property to determine gain.
Example: you sell stock to your daughter for $7000 in which you had a $10,000 basis. You cannot claim a loss for the sale. After several years, your daughter sells the stock for $12,000. Even though she only paid $7000 for the stock, the $3000 of disallowed losses is added back to the basis of the stock, so the gain is only $2000.
Losses from wash sales — the sale of securities that were repurchased within 30 days or where an option to acquire these same securities was purchased within 30 days either before or after the sale — are nondeductible.
Although qualified dividends are taxed at the same rate as long-term capital gains, they cannot be used to offset capital losses.
Special Rules Apply to Specific Types of Property Sales
There are special rules that apply to specific types of property sales that are discussed elsewhere on this website:
- home sale exclusion
- tax-free property exchanges
- installment sales
- qualified small business stock
- wash sales
- employee stock options
Reporting Property Sales
Property sales are reported in various forms. Form 8949, Sales and Other Dispositions of Capital Assets is used to report the sale of capital assets. Short-term gains and losses are reported in Part I and long-term gains and losses are reported in Part II. However, some transactions may be reported directly on Schedule D, Capital Gains and Losses. If the only capital gains are from a mutual fund or REIT, then neither Form 8949 or Schedule D needs to be filed: a gain can be reported directly on Form 1040.
For securities and commodities, brokers will send Form 1099-B, Proceeds From Broker and Barter Exchange Transactions to both the taxpayer and the IRS. The broker must report the basis in covered securities: stock acquired after 2010, mutual fund shares acquired after 2011, futures contracts and in certain bonds acquired after 2013, and certain other bonds, such as variable-rate and inflation-indexed bonds, acquired after 2015.
Form 4797, Sales of Business Property is used to report gains or losses for business property and by professional traders who use the mark-to-market method and for §1231 and §1244 stock sales.