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Friday, February 18, 2011

An overview of capital gains tax rules

The Capital gains tax is the government portion of profit(s) made from the sale of assets in the form of tax. Depending on how high one's capital gains are for a given fiscal year, capital gains tax can vary from between 0%-28% in the United States.

If capital losses are incurred on the sale of assets, those losses if combined with capital gains to be a net loss, can be deducted from total income possibly placing the tax filer in a lower tax bracket. This article will illustrate the concept of the capital gains tax, where to find information about filing capital gains tax and tips that may be helpful when preparing for capital gains or losses.

What capital gains tax is

In addition to being a tax on the profitable sales of assets, capital gains tax also applies to investments. Consequently, profitable sales of stocks, commodities, mutual funds, real estate, classic automobiles, bonds, collectibles etc. are all considered capital gains when sold from a non-commercial entity, i.e. individually and not through a business.

The U.S. Internal Revenue Service classifies assets and investments that qualify for capital gains and losses slightly differently. For example, losses on personal property such as non-investment vehicles or homes are ineligible for a capital loss deduction according to the IRS. Additionally, there is a limit of $1,500-$3,000 to the capital loss deduction. Moreover, capital gains tax rules are different for assets such as real estate as the following video explains.

Information on calculating and filing capital gains tax

Assets and/or investments that are held for one year or longer qualify for long-term capital gains tax whereas assets and investments held for less than a year are considered short term capital gains. (www.irs.gov). Short-term capital gains are legally subject to higher taxation rates than longer term capital gains.

Each year tax code may change through adjustments to tax code so tax rates can vary. Generally, the exact tax can be calculated using a capital gains tax calculator, and/or referring to IRS Publication 550 "Investment income and expenses (including capital gains and losses)"

After completing an IRS Schedule D and form 1040, one should be left with the correct amount of capital gains and/or loss to which tax, if any is applied. It is not until this value is calculated that a capital gains tax assessment can be made. Generally speaking, the higher the capital gains, the larger the capital gains tax will be, especially if the gain is over $28,000.00 (IRS Publication 550)

To illustrate, if Mr. Jones earns $50,000 in capital gains, and all these capital gains where from short-term holdings, that income will be added to his additional income if any on his form 1040 unless he invests through a business. If his gross adjusted income is above $75,000 his capital gains will be taxed at the highest amount because the capital gains were short term holdings, thus subject to higher taxation up to 28%, and his income tax bracket is at the 28% level.

Tips and techniques for recording capital gains and losses

Preparing for capital gains tax can be a year long process, accurately recording costs, profits, losses and investments bought and sold can assist in cross referencing and recording proper numbers on the IRS forms. Additionally, if a form 1099 is sent by a broker, the values on that form can be compared with personal records.

Additional examples of sales records include checks with memos, title transfers, transfer of deed and certificates of ownership. In the case of Roth Individual Retirement Accounts, capital gains earned through investment through the Roth IRA are tax deferred and therefore do not need to be recorded in a tax filing until withdrawal. The following tips may be helpful with working with capital gains.

• Read the tax code provided by the Internal Revenue Service: This helps identify what capital gains levels are taxable at which rate and may help lower tax.

• Properly deduct investment losses from capital gains so as to avoid over taxation

• Consider investing through a retirement account to avoid annual schedule D filings and capital gains tax before annuity or IRA distribution.

• If investing through a retirement account, capital gains within a Roth IRA may be non-taxable if the proper withdrawal criteria are met. (bankrate.com)

•If investing through a foreign owned corporate trust, capital gains tax rules may be lower.

•Investments through insurance policies may avoid capital gains tax through loans made from the policy and/or if the total cash value of the loan amounts to less than the total cost of financing the policy (babyboomercaretaker.com) Also, in the event of death or a claim on life insurance, the value of the policy is often not taxable.

Capital gains are a way for the government to tax income from the profitable sale of investments and assets. The tax rate for capital gains varies based on the 1) tax code for any given year 3) amount of capital gains in relation to individual income and 3) the financial vehicle and/or entity through which capital gains are earned. If capital gains are taxable in the United States, the Internal revenue service publication 550, form 1040 and schedule D are essential documents that may be referred to and/or completed in properly filing capital gains with the Department of the Treasury's I.R.S.


1. http://www.irs.gov/newsroom/article/0,id=106799,00.html
2. http://www.irs.gov/pub/irs-pdf/p550.pdf
3. http://www.moneychimp.com/features/capgain.htm
4. http://www.bankrate.com/brm/news/drdon/20011129a.asp
5. http://taxes.about.com/od/capitalgains/a/CapitalGainsTax.htm
6. http://tinyurl.com/663scfz
7. http://www.moneychimp.com/features/tax_brackets.htm