A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price. Capital gains may refer to “investment income” that arises in relation to real assets, such as property, financial assets, such as shares or bond, and intangible assets such as goodwill.
Tax on capital gains on individual or corporations is different. For example, capital gain recognized by a C-corporation is taxed at its regular tax rate.
Capital gains are taxed at various tax rates depending on holding period and the type of investment asset disposed.
|Type of Capital Asset||Holding Period||Capital Gain Tax Rate|
|Short-term capital gains (STCG)||One year or less||Ordinary income tax rates up to 35%|
|Long-term capital gains (LTCG)||More than one year||5% for taxpayers in the 10% and 15% tax brackets (zero percent starting in 2008)|
|15% for taxpayers in the 25%, 28%, 33%, and 35% tax brackets|
|Collectibles||One year or less||STCG tax rates up to 35%|
|Collectibles||More than one year||28%|
|Small Business Stock Gains (Section 1202)||More than five years||28% on the gain not excluded|
|Real Estate Main Home||One year or less||STCG|
|More than one year||LTCG taxed at 5% or 15% after any exclusion amount|
In addition to the federal capital gains tax, there will also be state taxes range from 1% to 9.3%.
Ordinary income is usually characterized as income other than capital gain. Ordinary income can consist of income from wages, salaries, tips, commissions, bonuses, and other types of compensation from employment, interest, dividends, or net income from a sole proprietorship, partnership or LLC. Rents and royalties, after certain deductions, depreciation or depletion allowances, and gambling winnings are also treated as ordinary income. A “short term capital gain”, or gain on the sale of an asset held for less than one year of the capital gains holding period, is taxed as ordinary income.
1. Ordinary Income
Generally speaking, if you live and work outside of the United States, then you can exclude all or part of your foreign wages from US taxation. To qualify for the foreign earned income exclusion, you must:
- Work and reside outside the United States.
- Meet either the Bona Fide or Physical Presence tests.
If you qualify, you will be eligible to exclude up to $87,600 (Tax year 2008) annually in foreign wages by filing I.R.S. Form 2555(Foreign Earned Income Exclusion). You must report even if no tax is due. Consult with professionals because the amount of the foreign earned income exclusion changes each year. This exclusion only applies to foreign earned income. In other words, any foreign unearned income, such as interests, dividends, capital gains, rental income, and etc. are not part of excluded income defined in Foreign Income Exclusion.
If you do not qualify for the Exclusion but paid tax in foreign countries, then you should claim foreign tax credit to reduce your tax liability.
2. Capital Gain
- Personal Property: Capital gain realized from a sale of personal property in foreign countries must be included in worldwide Income and reported on I.R.S. Form 1040, Schedule D.
- Real Property: Capital gain realized from a sale of real property in foreign countries must be included in worldwide income and reported on I.R.S. Form 1040, Schedule D and Form 4797.
In both cases, you will be able to claim foreign tax credit by filing I.R.S. Form 1116 if you paid tax in foreign countries.