An important factor that needs to be taken into account when deciding to sell an asset is how much capital gain tax you will have to pay on it. The tax on your gains can have a detrimental effect on your overall investment results. This is why you should think strategically about the specifics of when and how you sell your assets, in order to end up with the greatest return possible. Different asset classes and their respective capital gains are taxed at different rates, which will be explored in this article.
What is capital gain?
A capital gain is realized when you sell an asset for more than what you bought it for. If the asset appreciates in value, but you have not sold it yet, it is regarded as unrealized capital gain and you do not have to pay any taxes on it. A capital gain tax is only paid at the moment the gain is realized upon the sale of the asset.
Capital gains can be short-term or long-term. If you buy an asset and sell it within a year, you will incur short-term capital gains. Meanwhile, if you sell an asset a year or more after you have bought it, you will incur long-term capital gains. The timing of the sale of the asset is very important as short-term and long-term capital gains are taxed at different rates. To encourage the holding of assets for more than one year, the taxes on short-term capital gains are distinctively higher than long-term capital gains.
In order to get a rough estimation of what the net profit on your investment will be, it is important to calculate the capital gain tax of that investment first.
Capital Gain on Real Estate
Capital gains on real estate are realized when the property is sold. The capital gain is going to be the amount the property was sold for above the purchase price of the property, the closing costs paid and any other house improvement costs. There are different ways on how you can minimize the capital gain tax on the property’s sale depending on whether it serves as a primary residence or just as another investment.
If you sell a property with the intention of buying another one similar to it within a certain time, you can take advantage of the 1031 exchange rule and postpone your capital gain tax. According to this rule, investors can use the proceeds from the sale of one property in order to purchase another property. In this way, there is no actual income to be taxed. Even if you buy and sell these properties at a profit, you do not have to pay capital gains tax until you decide to cash out these profits.
On the other hand, if your home serves as a primary residence, you can get a capital gain deduction on it. If single, you are allowed to exclude up to $250,000 from the capital gain realized from the sale of your home, and $500,000 filing jointly and if married. Keep in mind that there are several eligibility requirements to get this deduction. First, the house has certainly served as your primary home for two of your last five years before the sale. If you already claimed this deduction on another house in the past 2 years or if you haven’t lived in the house for 2 years in the 5-year period before it was sold, you are not eligible for the capital gain deduction.
Capital Gain on Stocks and Bonds
The capital gain realized on the sale of a stock is simply what you sold the stock for minus what you paid for it together with any commissions and other fees charged. If you buy and sell the stock within one year, the capital gain will be regarded as a short-term capital gain and will be treated as ordinary income. In other words, the profit you made on the sale of the stock will be added to your income for that year. However, if you sell the stock a year or more after you have bought it, there is a long-term capital gain. Long-term capital gains on stocks are taxed at a flat rate of 15%.
Capital gain taxation on bonds is very similar to how the capital gains on stocks are taxed. However, there is one crucial difference. If an investor holds the bond until its maturity, there will be no capital gain at all.
It is important to note that you will only be taxed for these capital gains if your assets are not housed in any retirement account.
Capital Gain on Collectible Assets
Collectible assets are physical, tangible assets such as coins, metal, antiques, and artwork. These present a special case in the capital gain taxation rules. The short-term capital gain tax rate on collectible assets is found by using the income tax rate, while long-term capital gains are taxed at a fixed rate of 28%.
In conclusion, capital gain taxes are a factor to consider prior to making an investment. If you have a good idea of what type of asset you want to invest in and how long you plan to hold it for, then you will face fewer uncertainties when the time comes to sell the investment.