Capital Gains Tax

In addition to taxes that are paid on income each time you receive a paycheck, or the taxes that are added when you purchase a good at a store, taxes can also apply when you sell certain assets or goods. This is known as the capital gains tax.

Understanding a Capital Gain

A capital gain is the difference between what an individual purchases an item for and what they sell the item for. For instance, if you buy a stock for 45 dollars a share, but sell that same stock a few years later for 60 dollars a share, then your capital gain on that stock is 15 dollars.

Capital gains do not apply to all items that an individual purchases. For instance, disposable goods or food do not accumulate capital gains, even if you are able to sell them for more than you originally paid for them. Rather, capital gains are limited to capital assets, which are items that an individual buys for personal or investment purposes. Although stocks are the most common example, this can also include real estate, jewelry, art, or fine goods.

When an individual inherits a capital asset, or is given a capital asset as a gift, this is also subject to capital gains, even though the transaction is not precisely one of buyer-seller. In such instances, the capital gain is the difference between the value of the item when purchased by the gift-giver and when received by the gift-receiver.

Calculating Capital Gains Taxes

Determining the taxes to be paid on a capital gain first requires figuring out whether the gain is long-term or short-term. Short-term gains are those gains that are obtained when an item is sold or gifted within a year or less after being purchased. Long-term gains are gains that are received after the item has been in the possession of the owner for over a year. The difference is important because short-term and long-term gains are taxed at different rates. Generally, short-term gains are taxed at a higher level than long-term gains.

Short-term gains are taxed at an individual’s income tax rate. Thus, if you are in a 28% tax bracket, your short-term gains will be taxed at that level. Long-term gains, however, are subject to a fixed taxation rate, regardless of an individual’s income level. This rate is 15% for most taxpayers. However, if your income puts you in the 10% or 15% income tax bracket, you may be exempt from capital gains taxes on long-term gains altogether.

Offsetting Capital Gains

Taxpayers who are frequent investors may often find that while certain assets or investments do well in one year, resulting in capital gains, other investments do poorly, resulting in an overall loss in investment. If this loss is realized (meaning that you actually sell the investment or property for a loss) this loss can be balanced against any capital gains for purposes of overall taxation. Thus, if you realize $3,000 in capital gains by selling a valuable piece of art, but lose $1,000 by selling a stock that is performing poorly, you would only have to claim $2,000 in capital gains for tax purposes. Additionally, where your capital losses exceed your capital gains for the year, you may be able to claim an overall tax deduction.