Capital Gains Tax

What is the Capital Gains Tax?

Capital gains taxes are taxes which are levied on the financial gains realized from the sale of an investment asset purchased for a lower price. In the United States, capital gains taxes are levied on the sale of stocks, bonds, metals, and real property. Capital gains taxes must always be factored when determining the profits realized from investments and the consequences of selling property.

How Capital Gains Taxes are calculated

In the United States, capital gains taxes are taxed just as any other income of an individual or corporation over the taxable year. Greatly affecting the rate of taxation is when the property is sold and the gain realized. Realization of income occurs once the asset or property is sold and is taxed in the year in which it is sold.

1. Tax Rates

The rates of the capital gains tax is determined by when the asset is purchased and sold. “Long-term investments” are considered assets that are held for over one year and they are taxed at the favorable tax rate of 15%. “Short-term investments” are any assets that are purchased and resold within one years time. They are taxed at the ordinary tax rate, which will vary depending on the owner's yearly income and the taxation on their income from other sources.

2. What is taxable?

When calculating the amount that will be taxed for the capital gains tax, you must know the purchase price and the final sale price. The purchase price, also called the “cost basis”, is first determined. Then the sale price must be determined, which will be subtracted from the cost basis. If the sale price is more than the cost basis, the seller has realized a gain, which is the taxable amount. For example, if a home is purchased in 2002 for $100,000, and sold in 2010 for $120,000, the seller has realized an income of $20,000 in 2010 and will be taxed the appropriate percentage on the $20,000.

3. Realized loss of income

Unfortunately for the seller, not all investment assets are resold for a higher price. When a property is sold at a lower price than what it is purchased, the seller has received a loss. These losses can be calculated in the years taxes as a deduction from their taxes, according to the prevailing tax code at the time.

4. Avoiding immediate effects of the capital gains tax

Many different tax strategies exist for avoiding the incredible tax hit that may occur when selling a property that will face capital gains tax. For instance, a sale may be structured as an installment sale, the realized gain placed in a charitable trust, or other exchanges that will defer the tax date to a later time. While these strategies exist, a citizen of the United States is subject to taxation for exchanges anywhere in the world, therefore capital gains taxes cannot be legally avoided by purchasing or selling property in foreign nations.

Contact a legal or tax professional for more information on how capital gains taxes will affect you and strategies to best help you.