How Are Capital Gains Taxed?
So, what exactly is a “capital gain” anyway? You have a capital gain when you sell an asset for higher than the price you purchased it. For example, if you buy a diamond ring for $6,000 and sell it a few years later for $8,000, you would have a capital gain of $2,000. So, how are you taxed on that gain?
According to the IRS, a capital asset is nearly everything you own and use for personal or investment purposes. But securities, real estate and valuable collectibles are the most common taxable assets. You must report all capital gains on your income tax return.
Calculating Capital Gains
First, determine how much capital gain you’ve earned in a given year. To do that, take the sale price of the asset, then subtract the original purchase price. The original price is the “cost basis.”
- Purchases – If you purchased this asset, the cost basis is the price you paid.
- Inheritance – If you inherited it, the cost basis is the value of the asset on the day the original owner died.
- Gifts – If the asset was a gift, the cost basis is the original price, unless it was worth less at the time it was given to you.
Now that you know the cost basis, think about how long you’ve owned the asset. The length of time that you’ve owned the asset is called the holding period.
- Short-term capital gains – If you owned the asset for one year or less, it’s a short-term holding period. These are taxed at regular tax rates.
- Long-term capital gains – If you owned the asset more than a year, it’s considered a long-term holding. The IRS favors long-term investments over short ones, so the tax rates are lower.
Determining the capital gains you’ll pay all depends on your income tax bracket. The higher your income tax bracket, the more you will pay. If you’re in the 10 percent income tax bracket, you will pay 10 percent for your short-term capital gains. But if you are in the 28 percent tax bracket, you’ll pay 28 percent on short-term gains.
Long-term capital gains are taxed at lower rates that may vary depending on the type of asset and on your tax bracket. For more information on how capital gains are taxed, visit IRS.gov or consult your tax professional.
If you’d like to discuss short-term and long-term investments, talk to a Uwharrie Investment Advisor Representative.