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Tags: finance, income tax, understanding the capital gains tax
 In my earlier article titled “Capital Gains Tax—Learn the Basics” (December 17, 2008) we discussed the basics of this levy. In this article we will talk about the subject in depth. Understanding the capital gains tax system may help save you money that you may be shelling out to the Internal Revenue Service.
Let’s begin with a refresher by asking this question: what exactly are capital gains? Simply put, these are profits that comes out of a sale or transaction of any asset which is more than what you paid for it. Basically if you bought low and sold high, the difference between those two prices will be your gain.
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Conversely, if you bought low and sold even lower then you suffered a loss. As for the asset it is anything of value that is either owned by you personally or by a company that is used to make money. These can take the form of but not limited to stocks, bonds, real estate, or even the name of your company, otherwise known as goodwill.
Thus, capital gains or loss may refer to such investment in real assets such as property, financial assets such as stocks or bonds, and intangible assets such as goodwill. The net capital gains (gross gain minus gross loss) are then included as part of your income and are taxed accordingly.
Usually, capital gains are taxed preferentially as compared to ordinary income and the percentage is based upon, 1) your tax bracket, and; 2) the amount of time you held on to the asset before selling it. If you held the asset for about a year or less before selling it falls short-term capital gains and is taxed at your ordinary income tax rate.
Should the asset be in your possession beyond one year, it is considered long-term capital gains and is taxed at a much lower rate. Currently, this rate is pegged at 15% and 5% if you are in the two lowest income tax brackets. In calculating the taxable gain, the IRS uses the cost basis method.
The cost is the original purchase price, be it in cash or as a debt obligation. It also includes any amount you paid for sales tax, freight, installation and testing, excise taxes, legal and accounting fees, revenue stamps, recording fees, and real estate taxes. Before you figure out the capital gains or losses on any sale, exchange, or other disposition of property you must make certain adjustments (increases and decreases) to the cost of said property or asset.
The resulting adjusted basis includes any and all increases and decreases to said basis. Increases in the basis includes: 1) cost of improvements that has a useful life of more than 1 year, and/or; 2) improvements that increases the value of the property, or lengthen its life, or adapts it to a different use.
Examples would be the addition of an extra bathroom in your home, or putting a recreation room in your otherwise unfinished basement, or even putting up a fence or paving your driveway. Decrease to basis is the return of capital for the period you had the property. Examples include casualty or theft loss deductions and insurance reimbursements, and easements.
All gains and losses are reported in IRS Form 1040 Schedule D and as stated above, any net gain is taxed no higher than 15%. A net loss can be claimed if the amount of the loss is the lesser of $3,000 or the total net loss amount shown on line 16 of the 1040 Schedule D.
Remember, you may deduct losses only on investment property, not on property held for personal use. Knowing what can and what can’t be considered capital gains can go a long way in potentially lessening your tax liability and not have the IRS breathe down your neck.
About the author
The author of this article Rick Goldfeller is a successful underground Financial Analyst who has been advising and coaching individuals for many years. Rick recently published a book on how to manage your money and attract Wealth and Financial Freedom. More info on his Finance Planning course is available HERE.
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