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What is the Capital Gains Tax, and how does it Work?

Posted by Tom Hallissey on Apr 11, 2018 10:00:00 AM

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The capital gains tax often applies to the sale of assets. If you sell something for more than you spent to acquire it, your sale may be considered a capital gain. If so, you may have to pay taxes on the profits.

A Brief Explanation of the Capital Gains Tax

A common misconception is that capital gains taxes are only paid by the high-net-worth individuals. In fact, anyone who sells capital assets, like stocks, property or automobiles, may have to pay the IRS taxes on how much was earned from each sale. For example, if you made $20,000 in profits on stock sales this year, you will have to pay taxes on the profit.

The capital gains tax is progressive. For long-term gains, the rates are 0 percent, 15 percent and 20 percent depending on your tax bracket. Higher earners are typically taxed at a higher rate.

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Capital Losses

Keep in mind, your yearly capital losses can be used to offset gains when you file a tax return.

  • If your capital losses exceed your gains, you may be able to offset up to $3,000 of taxable income.
  • If you have more than $3,000 of capital losses in a given year, you may be able to carry those losses forward into future tax years.

In most cases, the sale of your home is exempt from this type of income tax.

Business Income

The capital gains tax does not apply to companies who buy and sell items, such as clothing stores. The profits from these types of sales are considered to be business income, which is taxed at a different rate.

The money you spend on items is a business expense, while the money you receive on a sale is business revenue. The difference is considered to be income, which is taxed at the same rate as income from employment.

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Long-term vs. Short-term Capital Gains

Capital gains are broken into two categories: short-term and long-term.

  • Short-term gain: when you make a profit on a sale of an asset you have held for one year or less.
  • Long-term gain: when you have held the asset for more than one year.

Tax law benefits those who hold assets for longer than a year. For example, short-term investment gains are taxed at a higher rate than stock portfolios you have held for several years.

If you are considering selling assets, it’s helpful to know how capital gains could affect the amount of money you ultimately take home. If you have additional questions, consult a local tax professional.

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