Capital Asset

Almost everything you own and use for personal or investment purposes is a capital asset. Examples are your home, household furnishings, and stocks or bonds.

The tax code defines the term “capital asset” by exclusion, i.e., everything you own except for specifically-excluded items.1 These exclusions insure that any income from those items are Ordinary Income.

Here are the most important items excluded from the definition of capital asset and therefore treated as ordinary income items:

Stock in trade, inventory, and property held primarily for sale to customers in the ordinary course of business. This exclusion insures that income from sales is ordinary income. Note: income from services is also ordinary income, but there's no specific

exclusion for “services” because tax law doesn't consider your services as something you own.

Accounts or notes receivable you acquire in the ordinary course of a sales business or in exchange for your services. This exclusion insures that income from sales and services remains ordinary income even if you sell on credit. Hence, e.g., a note or

other debt instrument isn't necessarily a capital asset. If you receive a note in lieu of money that would be ordinary income, the money you collect on the note will be ordinary income.

Supplies regularly used or consumed in the course of your business.

Copyrights, musical works, and art works you created. This exclusion insures that authors, artists, and other creative types receive ordinary income when they sell their works.

Best of both worlds. Your depreciable business property and any real property you use in your business are also excluded from the definition of capital asset. However, if you hold these types of property for more than one year before you sell them, the tax code provides special preferential treatment: net gain is taxed as long-term capital gain and net loss is taxed as ordinary loss. (See Capital Gain or Loss.)

See also Capitalization.