Understanding the Capital Gains Tax
A capital asset is virtually any type of property that you own, whether you use it for personal purposes or purely for investment reasons. There are specific rules from the Internal Revenue Service that spell out how to handle taxes on a capital asset when you sell it for a profit. Understanding the capital gains tax will help you during tax season.
Calculating the basis. Whether you are buying and selling items seeking to make a profit or you just happened to get a great deal on a vehicle you purchased and then restored, you must know the basis in that capital asset for tax purposes. The basis generally is what you paid for the asset, but it can include other costs as well. If you paid shipping, handling and installation or setup charges – all of those are part of the basis for that asset. Comparing the basis to what you sell the asset for tells you if you must pay any capital gains tax. By the way, if you lose money on the sale of a capital asset, that is important to note as well. The IRS allows taxpayers to deduct any capital losses from capital gains.
Length of ownership. The IRS has different capital gains tax rates depending on whether you owned the item you just sold for less than a year or more than a year. The tax rate is about 10 to 20 percent higher when you hold onto a capital asset for less than a year. That encourages long-term investing, according to experts.
Calculating gains and losses. If you buy and sell stocks on a regular basis, it’s possible that you may have both capital gains and capital losses in the same tax year. For example, you may decide to finally get rid of a stock that’s slowly been losing value. If you sell the stock for less than its basis – or the amount of money you have invested in that stock – you have a capital loss. If you don’t also have a capital gain for the year, it’s possible to either deduct the capital loss from other income or to offset capital gains in future years.
What about homes. Any sale of a house you lived in for at least two of the past five years is exempt from up to $250,000 of capital gains if you are single and up to $500,000 in gains if you are married and filing jointly. If you buy homes, renovate and repair them and sell them for a profit, there is no exclusion from the capital gains tax. That’s the general rule when homes aren’t purchased as your primary residence.