Capital Gains Tax

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What is a capital asset?

Almost any type of asset you own is a capital asset. This can include a type of holding, like stocks or bonds, or real estate, including your residence as well as investment properties, or something purchased for personal use, like furniture or a boat.

What are capital gains?

Simply put, a capital gain refers to the increase in the value of a capital asset when it is sold. A capital gain occurs when you sell an asset for more than what you originally paid for it.

definition of capital gain: the increase in the value of an asset relative to the price that was originally paid for it

Source: Investopedia

Capital gains are realized when you sell an asset by subtracting the original purchase price from the sale price. The Internal Revenue Service (IRS) taxes individuals on gains from the sale under certain circumstances.

How are capital gains taxed?

A capital gains tax is a tax imposed on the sale of an asset. The long-term capital gains tax rates for the 2024 tax years are 0%, 15%, or 20% of the profit, depending on the income of the filer. Short-term capital gains are taxed at your ordinary income tax rate.

flowchart to determine if you have to pay tax on the sale of an investment

The tax doesn’t apply to unsold investments or unrealized capital gains. Stock shares will not incur taxes until they are sold, no matter how long the shares are held or how much they increase in value.

When is capital gains tax paid?

Capital gains taxes are paid when taxes are filed, typically in April of the year following when the gains were realized. So, you will pay taxes on any capital gains you incur from January 1, 2024 to December 31, 2024 when you file your 2024 taxes in April of 2025.
This means that any efforts to reduce capital gains, such as tax-loss harvesting, must occur before December 31st of the year the capital gains were realized. Be sure to consult with your account about your tax strategy.

What are exceptions for capital gains tax?

A different standard applies to real estate capital gains if you’re selling your principal residence. $250,000 of an individual’s capital gains on the sale of a home are excluded from taxable income ($500,000 for those married filing jointly), if you have occupied the residence for at least 24 months of the last five years.

For investment properties, a 1031 exchange is a swap of one real estate investment property for another that allows capital gains taxes to be deferred. There are a number of rules for a 1031 exchange – for example, the proceeds from the sale must be held in escrow by a third party, then used to buy the new property; you cannot receive them, even temporarily. Be sure you are working with an accountant to ensure that all those rules are followed.

Determining the tax impact of selling an investment can sometimes be complicated. Meridian is happy to work with you and your accountant to create the best tax strategy for your unique situation.

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Categories : Financial Planning

Comments

  1. Dan says:

    Thanks for the explanation!!

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