Capital assets refer to anything you own and use for investment or personal purposes such as your house, land, building, car, trademarks, patents, machinery, leasehold right, jewelry or stock. When you sell a capital asset for more than you paid to obtain it, you must pay taxes on the gain. This is known as capital gain tax.
The profit or gain that rises from the sale of the capital asset is referred to as capital gain. The gain is charged to tax in the year the transfer of ownership takes place. However, capital gains are not applicable when the asset is inherited because no sale takes place. But if the person who inherits the asset sells it, capital gain tax is applicable.
Different types of capital gains are not treated the same. The tax rate varies dramatically between short term and long term capital gains.
Short Term Capital Gains
These are profits made from investments owned for a year or less. The clock begin ticking from the time the asset is transferred to you up to when you sell it. A major drawback of these type of capital gains is that they are not offered a special tax rate.They are applied the same tax rate as your normal income.
For example, if you have $60,000 in taxable income and $5,000 from short term investments, your taxable income will be $65,000. If you file tax as an individual, you are in the 25 per cent tax bracket and you will owe $12,021.25 in income tax. This amount can further be reduced if you qualify for tax deductions or credits.
Long Term Capital Gains
If you sell your capital assets at a profit after holding them for 366 days or more, it is classified as a long term capital gain. Long terms investments are more favorable than short term trading due to special tax treatment applied to them. They are applied a tax rate that is lower rate than short term capital gains especially for a person in the highest or lowest tax bracket.
Currently, the lowest tax bracket is applied a capital gain tax rate of 0%. This means that those in 10-15% tax bracket are not required to pay capital gain tax from assets held more than one year. Individuals in the 25%-35% tax brackets, capital gain tax is applied at 15 per cent while for the wealthy citizens who fall in the highest tax brackets, capital gain tax rate is 20%
The tax rate on long term capital gains is significantly reduced to encourage businesses and individuals to keep their investments.
Net capital gains
This refers to the difference between capital gains and capital losses. It means, if your investment ends up losing money instead of generating profit, you can use the losses to reduce the capital gain tax.
The IRS allows you to compare your capital gains and capital losses for the year to and determine your net loss or gain. In case you had a loss, you have a limit of $3,000 yearly to reduce the taxable income. You can also carry forward the additional losses to the following years to help offset capital gain taxes.