Posts tagged ‘IRAs’

January 9, 2012

How Capital Gains Tax Works

A capital gain is the increase of the value or potential value of an asset. A capital gains tax, is an income tax that treats increases in value as it increase in income. The US like most countries has a capital gains tax.

Under the Internal Revenue Code any increase in the value of an asset is treated as an increase in income. Generally the IRS only charges capital gains tax if you sell the item and gain a profit on it. If you sell something and lose money you will have a capital loss not a capital gain.

Something that you may not know is that the Internal Revenue Service regards almost anything you own as a capital asset. This includes investments, property, intellectual property rights, patents and anything else that could be of value. If your comic book collection doubles in value the IRS could consider that a capital gain.

How Capital Gains are Calculated

The method by which capital gains are calculated is actually very simple. If you own any sort of asset whether it’s a stock or an antique you simply subtract its current value from what you pay for it. If you purchased 10 shares of stock five years ago for $50 and sold those shares today for $300 you would have a capital gain of $250.

The normal capital gains rate for most assets is 12%. There are some exceptions to this for higher income individuals. Some lower income individuals will not have to pay a capital gains tax.

Under current law, you will have to report all increase in investment income except for funds held in tax-deferred instruments such as IRAs, life insurance policies or annuities. That is why it is often a good idea to keep a large percentage of your investment income in such vehicles. Capital gains and losses have to be reported on a Schedule D and line 13 of your 1040 tax return.

The best way to estimate capital gains is to use a capital gains calculator there are many of these available online. You can use these to figure out what your capital gains will be.

Capital Gains and Losses

Unfortunately you can only deduct certain capital losses on your income tax. If your personal property or investments lose value you cannot report that as a capital loss. If your investment property or business assets lost value you can report that as a capital loss on Schedule D. The IRS regards investment property losses as a business expense so they are deductible.

That means you could report a loss in value of your rental property as a capital loss. You could not deduct a loss in value of your home as a capital loss. The good news is that deductible capital losses can be deducted from your total income tax. That means you could deduct a loss on the sale of your rental property from your total income.

The limit for capital loss deductions is $3,000 for most taxpayers and $1,500 for those filing married or filing separately. If the amount of your capital losses exceeds those amounts you can carry them over to next year.

Always report all sales of investments and other assets on your taxes. If fail to report the IRS could consider it tax evasion and take action such as garnishment of your wages or bank accounts.

Steven Hart is a freelance writer and a Financial Advisor from Cary, IL. He writes about Annuity topics like Single Premium Immediate Annuities, What is an Annuity, and Current Annuity Rates.