What are five important things to know about capital gains tax? This tax, which few Americans understand, has been a mystery the financial market has been trying to unravel for private citizens. From learning how to maximize tax savings to understanding what counts towards this tax, here are a few things to keep in mind.
1. Two Types
One of the most important things to keep in mind is that there are two types of this tax: long-term and short-term. Long-term gains come from investments, including stock, big-item purchases such as property, and more, that are held for more than one year when the investment is sold. Short-term gains are held for less than one year and are taxed as ordinary annual income. Long-term gains are taxed at a smaller rate than income tax; ordinary income maxes out at 39.6 percent while long-term gains are capped at 20 percent.
2. Represent Profit From Investment
Another important thing to keep in mind is that capital gains are the profit from an investment; this means the tax only applies to the amount earned when an investment is sold for a larger amount than it was bought. This profit can change depending on how much a private citizen has improved the asset or if the asset actually deprecated in value since the original purchase. It’s also crucial to keep in mind that the original purchase price also includes taxes and fees, shipping costs, and any installation or setup charges one may incur; this depends on the type of asset that is being sold.
3. Gains can be Offset by Losses
As most investment articles will remind readers, gains are offset by any losses for investments; this refers to assets that are sold at a lower price point than the purchase price. This is important to remember because citizens are taxed on the lump sum of the capital gains they report; if a person reports a gain for one asset but a loss for another, they will only to be expected to pay for the gains. If in the event that capital losses outweigh the gains in any given tax cycle, a person may be able to offset that loss on up to $3,000 of other income. If the loss is more than this amount, than the remaining amount of loss can be added to future tax filings to also offset income during those years.
4. Real Estate Counts With Exception
Real estate, such as a personal residence, counts towards capital gains taxation to a certain extent. For private citizens, it’s important to remember that there are exceptions to this rule. If a homeowner buys a residence and then sells it for profit, it is not included in capital gains, provided that the homeowner lived and owned the home for at least two years within a five-year period prior to the sale and hasn’t sold another home in the same five-year period. This rule does not apply to people who flip homes, rent residences or move residences consistently.
5. Voluntary Until the Sale
It is possible to avoid paying this tax, which is why it’s an important thing to remember when tax time rolls around. Citizens are only expected to pay gains tax when they sell the asset; this means that as long as that individual holds onto the asset and does not sell it, they are not liable for the gains tax. Should they sell it, they will be required to pay the tax. An example of this would be Warren Buffet, a famous investor, who rarely pays gains tax because he holds onto his investments forever; he only sells assets when they decrease in value.
Investing can be overwhelming for those who are new to the financial sector. For every investment made, there are taxes that must be paid; learning as much about these taxes as possible before an investment is the best way to understand what would be owed at tax time. With these five important things to know about capital gains tax, citizens are better equipped to understand taxation requirements.
