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What is Capital Gains Tax?

2017-07-13T06:58:27+00:00

The term 'Capital Gains Tax' is included in the Investments edition of the Financial Dictionary. Get yours now on amazon in ebook or paperback format. Read more here...

Capital Gains Tax refers to as United States’ government assessed tax on capital gains. To better understand this idea, you must first grasp what capital gains actually are. Capital gains occur as individuals sell assets at a greater price than those at which they originally purchased them, known as the cost basis. Besides capital gains, there can also be capital losses. These occur in those instances when individuals sell assets for lower prices than those at which they initially bought them.

It is critically important to realize that Capital gains taxes only accrue at a set percentage on capital gains which are actually realized. This matters hugely as such gains only become realized after the owner sells the assets. Unrealized capital gains are those which occur as the assets in question gain in value but the owners do not sell them. It is up to the Internal Revenue Service to decide the rules on these capital gains taxes. Their rules state clearly that they may only levy such taxes on any capital gains for assets which the owner has both sold and collected.

It is always helpful to look at a few clear examples to clearly understand an involved concept. For investors who buy Apple stock at $145 per share and then watch it rise to $195, they have an unrealized gain of $50 per share. By keeping the Apple stock shares, the IRS is unable to tax these considerable gains per share. Yet when investors sell said shares of stock to lock in and cash out of these $50 per share profits, they become a realized capital gain. This event makes them taxable.

The same case is true with jewelry. Individuals could purchase a diamond necklace for $20,000 one year then sell it for $22,000 the following year. This $2,000 gain becomes realized as the owner sells the necklace. The Internal Revenue Service would then get its cut.

It is critical to understand which types of assets fall under the category of eligible for Capital gains tax. In theory every personally owned item is an asset which qualifies. In practice the most usually taxable assets are financial securities and instruments, valuable collectibles (such as art, coins, and stamps), and real estate. Securities would be any type of investment with value. The best examples of this are stocks, mutual funds, options, and bonds. Dividends that investors obtain from REIT’s Real Estate Investment Trusts and some mutual funds the IRS also gathers under its capital gains tax umbrella.

The same is true with real estate and real property. Any time investors or homeowners sell business or personal property and realize a profit on the transaction, this becomes a capital gain. The IRS assesses different taxable rates on business and personal properties. The sale of a primary residence enjoys substantial tax breaks from this onerous burden because of the Taxpayer Relief Act of 1997.

The law states that for any individuals who utilized a house, apartment, houseboat, or trailer as their primary residence for minimally two out of the previous five years, they are allowed to exclude as much as $500,000 of capital gains from the property sale for tax purposes. This amount applies to married couples filing jointly. Those who file as individuals only can exclude out as much as $250,000. Only profits which exceed these amounts would be taxable.

It is also important to keep in mind that the IRS prefers longer-term investments to shorter-term ones. This is why they assess higher capital gains tax rates on shorter held investments than they do on the longer ones. Every asset class also can have its own particular holding periods for what constitutes short or long term investments.

The term 'Capital Gains Tax' is included in the Investments edition of the Financial Dictionary. You can get your copy on amazon in Kindle or Paperback version. See more details here.