3 Things You Need To Know About Capital Gains Tax
Updated: Dec 9, 2019
If you're thinking about investing in a capital asset, whether that means real estate, stocks or a new car — yes, cars count too, in fact, anything you own can be quantified as a capital asset — then you should also learn about Capital Gains Tax, and what it could mean for you.
In this guide, we're taking a look at what capital gains tax is, and three essential things you need to know about it.
What is Capital Gains Tax?
Capital gains tax is a tax that's levied on the profit received from the sale of an asset. Some of the most common capital gains realized are from real estate, stocks and bonds, and precious metals such as gold. Put simply, capital gain occurs when you sell something for a higher amount than you spent purchasing it.
There are two different types of capital gains tax;
Short-term capital gains tax is levied on the profits of an asset owned for one year or less and has a tax rate that equals your current income tax. Long-term capital gains tax, on the other hand, is levied on the profits of any asset owned for longer than 12 months. Long-term capital gains tax rates are calculated differently, depending on your overall taxable income, and can fall into a 0%, 15% or 20% tax bracket.
Your Home Is Usually Exempt
The most significant asset that the majority of people own is their home. Real estate is also one of the easiest ways to realize a substantial capital gain on a sale. Fortunately for homeowners, as long as they meet three conditions, they can typically exclude part, or even all, of their profit from capital gains tax.
For example, if you own your home for a period of at least two years, and you use it as your primary residence for at least two years in the previous five — AND you also haven't excluded the gain from another home you've sold in the two year period before the sale — you can exclude up to $250,000 of the gain as a single-filer, and $500,000 if you file jointly with your spouse.
Capital losses can offset capital gains
Unfortunately, assets don't always increase in value. If you end up selling something for less than it cost to acquire it, you have made what is known as a capital loss — however, according to the tax code, capital losses can be used to offset capital gains.
For example, if you sell some stock and make a long-term gain of $30,000, but also sell another stock and realize a long-term loss of $5000, your capital gains are effectively reduced to $25,000. It's important to remember that you cannot use capital losses on personal property to offset capital gains.
A capital loss can also be carried forward to offset gains in future years, or alternatively, if your overall capital loss is up to $3,000 greater than your capital gain, you can also use it to offset other income you may have.
Business Income Is Not the Same As Capital Gains
If you purchase items to sell on for a profit, and you operate as a business, the IRS will tax you as if you've made a business revenue, not a capital gain.
For example, if you buy an antique that you sell after 3 years for a profit of $15,000, you will be taxed as if it were a long-term capital gain. In comparison, if you buy and sell antiques frequently for profit, it will be taxed as business income, and you will be subject to employment taxes.
If you'd like more information about how a capital gain will specifically affect you and your taxes, you should seek the advice of a certified accountant. Alternatively, if you'd like some general financial advice and useful tips on how you can work your way towards early retirement, check out our podcast.
All information and materials in this article are for educational purposes only. Opinions expressed in this article are based on information considered reliable, but The Daily Money Show cannot guarantee the accuracy of the information nor should it be relied upon. The information discussed in this article should not be used as a recommendation to buy or sell securities nor should it be taken as investment advice. The Daily Money Show is not a Registered Investment Advisor or Broker Dealer. The Daily Money Show is not an accounting firm and does not give tax advice regarding any security or real estate transaction. You may want to consult with an accountant, attorney, real estate agent or financial advisor before proceeding with any transaction regarding securities or real estate.