Taxes Tips for The Average Joe

The Mystery of Capital Gains Tax

If you’re selling any capital asset, you should know that you may be subject to capital gains tax. And the Internal Revenue Service says nearly everything you own is counted as a capital asset, whether you purchased it for personal consumption (for example, your car or your flat screen TV) or as an investment (for example, stocks or real estate).

Selling something for an amount that exceeds your “basis” for that item, that excess serves as your capital gain, and you need to report it on your taxes as such. Your basis is what you spent to get the item, including sales, excise and other taxes and fees, as well as charges for shipping and handling fees, and installation and setup. Furthermore, any improvement expenses that raise an asset’s value (for example, remodeling your rental condo’s bathroom) may be added to your basis. In the same manner, your basis will decrease as an asset depreciates.

Usually, your home will be exempt from capital gains tax. The biggest asset people usually have is their home, and depending on market conditions, they can make a huge capital gain when they sell it. The good news is it’s possible to exclude some of that gain or even all of it from the capital gains tax, as long as the following conditions are satisfied:

> You owned the home and used it as your main residence for no less than two years within the five-year duration preceding the sale; and

> You haven’t excluded the gain from a previous home sale occurring within two years before the latest sale.

If the above conditions are met, you can exclude a maximum of $500,000 from your gain if you’re married and file jointly with your spouse, or $250,000 if you’re single.

How Length of Ownership Matters

Selling an asset you have owned for over a year, your gain will be considered a “long-term” capital gain. If your length of ownership is less than a year, it is considered a “short-term” capital gain. And taxes on short-term gains are drastically higher than those on long-term gains. If you’ve held an investment for barely a year, the capital gains tax rate is often higher – probably between 10% and 20% or even more.

This tax treatment is one of the specific advantages of applying a “buy-and-hold” investment technique, compared to a strategy that requires continuous buying and selling (day trading, for example). Also, taxpayers in the bottom brackets typically don’t have to pay taxes on long-term capital gains. In other words, between short-term and long-term capital gains, the difference could actually mean that a person will pay taxes or will not pay any taxes at all.

Capital Losses Offsetting Capital Gains

If you sell something at a price that is less than its basis, you have a capital loss. However, this is only true for capital losses from an investment, not from a personal property sale.

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