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What Are Capital Gains? How Are They Taxed?

Capital gain is the profit you get from selling an investment or asset. It is an increase in the value of an asset. A capital gain is considered gain only when the assets have been sold and the profits realized. 

Generally, capital gains relate to funds and stocks as a result of their intrinsic price volatility. Also, capital gains occur with securities that are sold for a price higher than their purchase price. The profits realized from capital gains are taxable.

How Do Capital Gains Taxes Work?

Capital gain tax is the tax paid as a result of the increase in the value of an investment after it is sold. These taxes are paid from the profits made, and they do not apply to unsold properties or investments. 

For stocks or shares that appreciate, there won’t be any capital gain tax on them until they are sold. When these assets or investments are sold, the gains gotten are often referred to as being “realized”. Every investment has a tax rate attached to it. 

The tax rate on most net capital gain is no higher than 15% for most individuals. However, depending on your taxable income, the basic capital tax rate charges are 0%, 15%, and 20%. The tax rates paid on residential properties are most times different from other assets you own. 

Usually, you are charged 28% for residential properties, and 20% for other assets. Also, tax rates are charged based on the term of the capital gain. The taxes charged for a short-term gain is different from the long-term gain. 

Although, there are exceptions to capital gains as different rules apply to different assets. These exceptions include capital gain tax from collectibles (such as precious metals, arts, or antiques), and owner-occupied real estates.

Which Assets Qualify for Capital Gains Treatment?

“Treatment” refers to the length of time you are required to own an asset. The treatment of an asset usually determines if it’ll be regarded as a long-term or short-term asset. Capital gain treatments are special taxes imposed on your investment capital gains by tax codes.

Capital gain taxes apply to capital assets as such, not all assets qualify for capital gain treatment. Some assets that could pass as capital assets are:

  • Bonds
  • Jewelry 
  • Stock
  • Collectibles 
  • Your home
  • Your vehicle

Note also that not all capital assets you own may qualify for the capital gain treatment. Some of these assets are:

  • Depreciable business properties
  • Business inventories

What Is Short-Term Capital Gains Tax?

A short-term capital gain tax is a tax paid on the profits made from the sale, or transfer, of personal investment properties. These assets are usually held for a defined short period.

The short-term period varies for different classes of assets, and so does the amount of tax paid. These gains are taxed as ordinary income, and short-term investors are often charged at a higher tax rate in the U.S.

What Is Long-Term Capital Gains Tax?

A long-term capital gain tax is a tax paid on the profits realized from the sales or transfer of an individual’s asset that has lasted for up to two years or more. The long-term period and tax payment also vary for different classes of assets. However, the tax system in the U.S is more beneficial to long-term investors.

Special Capital Gains Rates and Exceptions

There are some exceptions to the capital gain rates we have explored so far. The special capital gain rate gives a basic understanding of what these exceptions are and when they can be incurred. They are:

Collectibles

Capital gains on collectibles which include arts, jewelry, antiques, stamp collections, and metals are taxed at 28% rates regardless of your income. 

The Net Capital gains from selling collectibles are taxed at a minimum of 28% rate. If your tax bracket is lower than 28%, you’ll be charged with a higher tax rate, but if it’s higher, you’ll be restricted to the 28% tax rate.

Owner-Occupied Real Estate

Owning real estate can be a source of steady income for investors but selling these estates can produce a huge tax bill due to capital gains.

Real estate capital gains are taxed with a different standard for single individuals when compared to married couples. However, the gain from selling real estate properties is taxed at a minimum rate of 25%.

Here is how it works: 

The capital gain you get from selling the house as an unmarried person is $250,000. But for couples filing jointly $500,000 may be their capital gain.  However, this is only possible if the seller has lived or owned the home for two years or more.

Investment Real Estate

Investors with real estate frequently take depreciation deductions against income to show the constant deterioration of their properties. This deterioration in the assets is usually not related to an appreciation in the value of the property by the real estate market. 

The deductions reduce the amount you are supposed to have paid for the property, which in turn increases your taxable capital gain when you sell the property. This increase in taxable capital gain is a result of the gap in the property value after reductions, making its selling price higher.

An illustration to further buttress this:

Assume you paid $200,000 for a building, and you claimed $10,000 in the depreciation of the building, subsequently, you’ll be treated like you paid $190,000 for the building.

Now the $10,000 you paid is regarded as the depreciation deduction recapture. The tax rate applied to this recapture is 25%. So if you eventually sell off the building for $210,000, then there’ll be a total capital gain of $20,000. 

The $10,000 in the sale of the estate is regarded for recapturing of deductions from the income, the remaining $10,000 of the capital gain will be taxed as one of the 0%, 15%, or 20% tax rates.

Investment Exceptions

If you earn high incomes, then you may be subject to another levy which is the Net Investment Income Tax (NIIT). This tax is imposed by the Internal Revenue Code and applies a rate of 3.8% tax on the investment income of individuals, estates, and trusts that have income in threshold amounts.

If you are married and you intend to file a joint account or a surviving spouse, your threshold amount to pay is $250,000. However, if you are the head of household or you are single, you will pay $200,000. Lastly, if you are married but filing separately, you will pay $125,000.

How To Compute Your Capital Gains

As an investor, here is how you can compute your capital gains and probably losses too. First, you sum up all your like-kind gains and losses together. Then you sum up your short-term gains to get a total short-term gain. Do this for both your short-term losses, long-term gain, and losses likewise.

To get your net short-term gain or losses, you place your total short-term gain against your total short-term losses. The same is done for your long-term gains and losses. After doing this, the values obtained from the total of the short-term and long-term gains and losses should correspond to produce the final net capital gain or loss. 

Bottom Line

An understanding of capital gains will help you know what price to sell your assets so you don’t incur losses. As an investor, being able to calculate your capital gain is needful. 

However, it is possible that due to the many things you may be involved with, computing these gains may be somewhat “task-full.” Thanks to financial advisors who make this seem like a walk in the park. 

Employing the skill of a financial advisor will help you get the accurate values you need to keep track of your profits and also help you understand how to pay your tax return.