When a taxpayer sells or exchanges a capital asset at a gain, he or she may benefit from the beneficial capital gains tax rate. On the other hand, if the taxpayer sells or exchanges a capital asset at a loss, then he or she may only use the capital losses to offset his or her capital gains.
A special rule applies to individual taxpayers in that they may use up to $3,000 of capital loss to offset against other noncapital income per year. Any remaining disallowed capital losses of an individual taxpayer are usually carried forward to offset future capital and/or noncapital income.
What Is a Capital Asset?
A capital asset is basically all assets (whether or not connected to a trade or business) except for the following items:
1. Stock in trade and other inventory property of the taxpayer;
2. Property held primarily for sale to customers in the ordinary course of business;
3. Depreciable property and real property used in a trade or business;
4. A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property, held:
(a) by a taxpayer who created the property; or
(b) in the case of a letter or memorandum, by a taxpayer for whom the property was prepared or produced; or
(c) by a taxpayer whose basis in the property is determined by reference to the basis of those who created it or for whom the property was prepared;
5. Accounts and notes receivables acquired in the ordinary course of business for services provided or for sale of stock in trade, inventory, or property normally held for sale to customers;
6. United States government publications that are acquired by the taxpayer (or received from someone else) who bought the property at a price that is lower than the price which the publications are sold to the public;
7. Commodities derivative financial instrument held by a commodities derivatives dealer;
8. Hedging transactions which are clearly identified as such; and
9. Supplies regularly used or consumed by the taxpayer during the ordinary course of business.
What Are Some Examples of Capital Assets?
The more common capital assets include the following:
1. Stocks and bonds held as an investment by the taxpayer;
2. Personal residence;
3. Personal automobile; and
4. Personal jewelry.
Is a Patent a Capital Asset?
Unlike a copyright, a patent is usually a capital asset in the hands of its original inventor or an unrelated party who purchased the patent from the original inventor. A patent might be excluded from capital treatment if the inventor is a professional who is in the business of selling patents to customers. However, exceptions may apply to professional inventors if certain requirements are met.
Will My Residence Qualify as a Capital Asset if I Am Renting It Out?
If the taxpayer holds his or her residence out for rent, it will be deemed to be used in a trade or business and therefore will not be a capital asset. However, the property may still qualify for capital treatment if certain requirements are met. Complication arises when the taxpayer changes his or her purpose for holding the residence; the character of the asset needs to be determined on a case by case basis under the facts and circumstances of the taxpayer.
Do I Need an Attorney to Help Me with My Tax Problems?
Tax laws are complex and ever-changing. Although there are various tax preparation softwares on the market that may help you with your tax problems, they cannot provide the same level of service that an experienced and knowledgeable tax attorney can. If you are unsure about the characterization of your asset or you need someone to represent you before the IRS, a tax attorney can help you.