“How Will My Investment Income be Taxed?” An Overview of the Capital Gains Tax

Whenever we make money, the IRS is waiting to take its share. We’ve long since come to terms with the reality of income taxes, but the capital gains tax, which applies whenever we sell capital assets such as stocks and real estate, can still be confusing.

A capital gain results when an asset sells for more than its costs. For example: if you buy a gold watch that costs $4,000 and sell it later for $5,000, the capital gain is $1,000. The capital gains tax absorbs a percentage of all realized gains: “realized” meaning that the asset has been sold.

Taxable Gains

The most common taxable assets are valuable collectibles, real estate, and securities, which are any investment contract or financial instrument that has value. They include options, stocks, and bonds.

If you sell any property or real estate and realize a profit from the sale, it is considered a capital gain. Sales of fine art, jewelry, wine, rare coins, and other valuable collectives are also taxable as capital gains.

Calculating Capital Gains

To calculate how much you’ve earned in capital gains, take the sale price of a capital asset and subtract its cost (usually the original purchase price). Things get more complicated if you’re not the one who originally purchased the investment.

The original purchase price of an investment is known as the cost basis. If you bought it, the cost basis is the price you paid for it. If the investment was inherited, the cost basis is generally its value on the date the original owner died. If you received it as a gift, then your cost basis carries over from the giftor to you (e.g., their original purchase price).

Next you need to determine how long you’ve owned the asset. This time is known as the holding period. It can be short-term (owned the asset for less than a year) or long-term (owned the asset for at least a year). This is important because long-term capital gains are subject to more favorable tax rates. Note that inherited property is automatically treated as long-term regardless of how long you actually held the asset.

Your income tax bracket is the most important factor in determining your capital gains tax. The higher your tax bracket, the more you will pay in capital gains tax.

Lowering Your Capital Gains Tax

Avoiding short-term investments is the easiest strategy for lowering your capital gains tax. You can also shelter as much income as possible in retirement accounts like Traditional IRAs, Roth IRAs, and 401(k)s. When you sell an asset for less than the original purchase price, it is a capital loss and can be subtracted from your capital gains to reduce your taxable earnings. You can deduct up to $3000 of net capital losses (capital losses minus capital gains) to offset other income. Losses in excess of the deductible amount can be carried forward to future years until exhausted.

If you have questions about capital gains taxes or your investment strategy in general, I can help you make sense of them. Give me a call today to learn more!

Share this on...Share on FacebookTweet about this on TwitterShare on LinkedInShare on Google+Email this to someone

Written by Desnoyers CPA

Desnoyers CPA

Known for her friendly, outgoing nature and her rare talent for financial foresight, Lydia Desnoyers has been serving individuals and small businesses in Florida since 2010. After earning her Master’s Degree in Accounting from Nova Southeastern University and her Bachelor’s Degree in Accounting from Florida State University, she became a Certified Public Accountant and a Certified Fraud Examiner.