What is the Capital Gains Tax?
One of the most talked about, and controversial taxes that investors must deal with is the capital gains tax. Depending on your level of education in investment types and financial law, you may or may not know what the capital gains tax is. The capital gains tax is something which affects almost every investment type, from mutual funds, collectibles, bonds, or options. Essentially, the capital gains tax is a tax on anything which provides capital gains. Capital gains are the profits from the sale of an item of non-inventory nature bought for an amount less than the transaction value.
Because capital gains taxes can apply to a wide variety of investments, it is important to take each of the major components of the tax, and see how accurately it will apply to you and your investments. Below, some of the most important and far-reaching facts and effects of the capital gains tax will be explained, so that it is no longer a mystery, but something which we can all understand.
How Can You Calculate Capital Gains?
When dealing with the capital gains tax, it is important to know exactly how the IRS is going to define what your capital gains are. There is an easy method of finding out what your capital gains are, and then you can see what percentage of tax on that amount. Subtracting the amount that you paid for investment from the sales price of the investment is Capital Gains. The price that you paid for the investment also includes any broker commissions.
The cost of the investment is calculated using one of the several methods. For those who purchased their own investment, you simply use what you paid for the investment. If you have inherited an investment, on the other hand, you must use the value of the investment as it was when the person who passed the investment onto you died. Finally, if the investment is like a gift from a third party, the cost of the investment is the cost that was paid by the third party. However, the caveat with all the gifts investments is that if the market value of the investment is lower now than it was when purchased, the lower value is used.
Types of Capital Gains
When the IRS calculates capital gains, they sort capital gains into two categories – longer-term capital gains and short-term capital gains.
Long-term capital gains are any profits made on any and all investments held for a minimum of a year. They will have a different tax rate than short-term capital gains. For those investors who are in the 25% or higher tax bracket, you will be taxed at a rate of 15%. For those who are in the 39.9% tax bracket, your capital gains will be taxed at 20%.
Short term capital gains are any profit or gains made on investments which the investor held for less than a year. While long-term capital gains have fewer delineations within their tax bracket regarding how much tax the investors will face, short-term capital gains have more delineations. The exact percentage of tax depends on the tax bracket you belong. However, the IRS encourages long-term investment much more than short-term investing, due to its lower risks. As such, long-term capital gains are taxed at a lower rate than short-term capital gains.
Residential Real Estate Capital Gains Tax
When dealing with the capital gains tax regarding your residential home, you may find that you are exempt from the capital gains tax. If you have been in your home for at the minimum two years in a row, you may be able to exempt yourself from the tax. Your income must also fall into the income bracket of $250,000 for taxpayers who are filing on their own, and $500,000 for any married couples which will be filing their taxes jointly. If you do not find yourself exempt from this tax, the capital gains tax will be applied to any money which you make from the sale of your primary home.
How to Minimize Capital Gains Taxes
While taxes are inevitable, nobody wants to pay more taxes than they have to. Most people will want to find strategies which will help them decrease the overall amount that they will have to pay for their investments and capital gains. One of the most efficient ways in which you can limit and reduce a number of capital gains taxes that you will have to pay is to get rid of any investments that are costing you money in a year in which you have offsetting capital gains.
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