Capital Gain Overview
A capital gain occurs when you purchase an asset and subsequently sell it for more than you paid for it. The capital gain is the difference between the final sale price and the cost basis. Cost basis is the “cost” to the owner. It can be adjusted from the original purchase price because of depreciation and other adjustments.
Two Types of Capital Gains
You can have two types of capital gains. First, there are long-term capital gains. These are capital gains where you own the asset for at least one year. Long-term capital gains are taxed at more favorable rates than other capital gains or ordinary income. The second type is short-term capital gains. These are capital gains where you own the asset for less than one year. Short-term capital gains are taxed at ordinary income tax rates. Thus you can see that there is a distinct advantage to holding on to assets for at least a year to receive more favorable tax treatment.
Areas of Capital Gains
You can incur a capital gain in many different areas. The most common is in stocks and mutual funds. You incur a capital gain when you sell a stock or mutual fund for more than you paid for it. Also, if you own mutual fund shares, you may be issued capital gain distributions even if you do not sell. This is because mutual funds incur capital gains when they sell their underlying assets. Since mutual funds do not pay taxes, they pass on capital gains to shareholders. For more information on stock capital gains click here.
Another area is in real estate. You incur a capital gain when you sell a property for more than you paid for it. To calculate a real estate capital gain, simply subtract your adjusted cost basis from the net sale price. There are several ways to get around real estate capital gains taxes. See this article for more information. First, if it is an investment property, you can conduct a 1031 exchange, also called a like-kind exchange. This is where you roll your capital gains into a new property. There are many rules and you need to work with a qualified intermediary. Another way to avoid capital gains is with a personal residence. If you meet certain requirements, the IRS allows you to waive significant capital gains on your personal residence. For either of these situations seek competent tax advice.