Good Information to Know About Capital Gains Tax
Capital gains tax in America is applied to several different types of investment transactions throughout the country and is a very important part of tax collections for a significant amount of people in America. What is crazy is that most people have little knowledge about how capital gains tax works. It is within everyone’s best interest in America to make sure they are informed about how capital gains tax can impact their investment decisions.
What are capital gains?
Capital gains are used to describe the profit that someone makes from selling or trading what is considered a capital asset. This does have certain exceptions but a capital asset, in simple terms, is any property that you own. This can include investment property like stocks, bonds, cryptocurrency, real estate, and collectibles. It can also include property that you retain for personal use like a car, your home, or the furnishings inside your home.
There are a large number of special rules that can affect a property’s classification or treatment when it comes to being classified as a capital asset. For example, if someone sells an item frequently to customers this property might not be considered a capital asset. Instead, this is considered as business inventory. Because of this, profits from the sale of this inventory will not be subject to capital gains tax. For this purpose, someone needs to be careful of how many real estate investment properties or any other item they own they sell because it could be treated as inventory and the tax will then become higher.
Another type of property classification in America is intellectual property. This can include items with a patent, inventions, models or designs, a recipe, a formula or a process, copyright, written literature, music, art, and the like. This is also not considered a capital asset as long as it is held by the person who has created it or in the case of a letter or memorandum by the person for whom it was created.
When is a capital asset taxed through capital gains?
A capital asset is taxed by capital gains when it is “realized.” A capital gain or loss for that matter is generally realized for tax purposes when the capital asset is sold. Capital assets can continue to appreciate or increase in value without becoming taxable as long as you continue to own them. So, if you have a loan against a capital asset this will not give realization or make it subject to a capital gains tax. This is why many real estate investors refinance properties instead of selling them.
There are other events that can cause realization including when a property is involuntarily converted or taken by the government as part of eminent domain. Also allowing others an exclusive right to use the property can be treated as a capital gain. Capital gain is also realized when the property is exchanged for other property.
The exchange of property is generally taxable but there are some special rules that apply to like-kind exchanges of real estate. One of the main rules is that you need to find a replacement property within a certain timeframe to help reduce or eliminate the taxable gain.
Calculating taxable capital gains
Taxable capital gain is most often equal to the value that you receive when you sell or exchange a capital asset minus your basis in the asset. The basis is what you paid for the asset originally. In some cases, this is an easy calculation and then in others, it can be more complicated. It is always best to report on the highest basis possible to keep the taxable portion of your profit as low as possible.
Determining a basis can become complicated if you have inherited an asset for example instead of purchasing it. If someone gives you a capital asset the donor's basis will carry over to you. There are a number of varying different items that can adjust or change the basis and as such is always best to work with a tax professional when determining your basis and exactly how much capital gains tax you are responsible to pay.
Reporting capital gains tax on a return
When filing an annual tax return there will be some additional forms you will be required to fill out if you have had a capital gain or loss during the tax year. Reporting of capital gain or loss is done on form 8949. This includes capital gains and losses that have been included and reported on a 1099 or K – one form.
To report depreciable property, you can use form 4797 including reporting real estate for investment.
If you are selling a home in the Columbus area and are unsure if you will be subject to a capital gains tax it is always best to make sure you are consulting with a real estate professional as well as a tax professional. You want to make sure you are taking the right steps in selling your home that will not come with a huge capital gains tax responsibility.
For more information on purchasing real estate in Columbus and surrounding areas please contact us anytime.