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Have you heard the term "capital gain" or been told a "capital loss" is what helped on your tax return? Did you know what that meant? We've got some answers for you below!
First we're going to cover a few definitions for those new to capital gains and losses.
Capital Assets
Most property you own and use for personal or investment purposes is a capital asset. For example, a house, furniture, car, stocks, and bonds are capital assets.
Noncapital Assets
A capital asset is any property held by you except the following.
Stock in trade or other property included in inventory or held mainly for sale to customers.
Accounts or notes receivable acquired in the ordinary course of a trade or business for services rendered or from the sale of stock in trade or other property held mainly for sale to customers.
Depreciable property used in a trade or business, even if it is fully depreciated.
Real estate used in a trade or business.
Copyrights, literary, musical, or artistic compositions, letters or memoranda, or similar property created by the individual’s personal efforts, prepared or produced for the individual, or received from a person who created the property.
Supplies regularly used in a trade or business.
Investment Property
Investment property is property held for the production of income or anticipated appreciation in value. A gain or loss from the sale or exchange of investment property, such as stocks and bonds, is a capital gain or loss.
Holding Periods
Capital gains and losses must be separated according to how long you held or owned the property.
Short-Term -- The holding period for short-term capital gains and losses is one year or less.
Long-Term -- The holding period for long-term capital gains and losses is more than one year.
Inherited Property -- Inherited property is considered held long term regardless of actual time held by you, the beneficiary.
Securities Traded on an Established Market -- For securities traded on an established securities market, the holding period begins the day after the trade date the securities are purchased and ends on the trade date the securities are sold. This is very important for individual investments and mutual fund investments
Mutual Funds
A mutual fund is a regulated investment company generally created by “pooling” funds of investors to allow them to take advantage of a diversity of investments and professional management. These types of funds are very popular with investment companies or brokerages. If you've every received a Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, that caused a bit of havoc in your personal return, it was probably from the gain of a mutual fund in which you were invested.
Mutual Fund Basis
Shares in a mutual fund may be acquired at various times, in various quantities, and at various prices. When shares of a mutual fund are sold, it is necessary to determine which shares were sold and the basis of those shares. You can use either a cost basis or an average basis to calculate gain or loss.
Cost Basis
Cost basis can be used only if you did not previously use an average basis for a sale of other shares in the same mutual fund. To calculate cost basis, use one of the following methods.
Specific share identification. The adjusted basis of specific shares can be used to calculate gain or loss if those shares are adequately identified. Adequate identification requires you to:
Specify to a broker or other agent the particular shares to be sold at the time of the sale, and
Receive confirmation in writing from the broker or agent within a reasonable time of your specification of the particular shares sold.
First-in first-out (FIFO). If the shares sold cannot be identified, the oldest shares owned are considered to be sold first.
Average Basis
Average basis is calculated by dividing the total cost of shares owned by the total number of shares owned. Once average basis is used to report gain or loss from a mutual fund, it must be used for all accounts in the same fund. However, you may use a different method of calculating the basis for other mutual funds, even those within the same family of funds.
Transfer or Exchange of Mutual Fund Shares
Any exchange of shares in one fund for shares in another fund is treated as a sale. This is true even if shares in one fund are exchanged for shares in another fund within the same family of funds.
Reinvested dividends are dividends paid that you opt to use to buy more shares of stock rather than receive the dividends in cash. The dividends are reported as income, and the shares of stock owned and cost basis increases.
Capital Gain Tax Rates
Tax rates that apply to net capital gain are generally lower than tax rates that apply to other income. These lower rates are called “maximum capital gain rates.” Net capital gain is the amount by which net long-term capital gain for the year is more than net short-term capital loss. The maximum capital gain rates are 0%, 15%, 20%, 25%, and 28%. If tax is calculated using the maximum capital gain rate, and the regular tax computation results in a lower tax, the regular tax computation applies.
Note: There are rates that apply when taxable income exceeds the 24% tax bracket for regular income tax purposes. Those special circumstance rates are:
Capital Gain Distributions
Capital gain distributions are paid by a mutual fund or real estate investment trust (REIT) from net realized long-term capital gains.
Capital Loss Limitation/Carryover
If capital losses are more than capital gains, the difference must be deducted even if there is no ordinary income to offset it. The annual limit on the amount of capital loss
that can be deducted is $3,000 ($1,500 for Married Filing Separately).
We know that capital gains are never easy to plan for, and we know that it can be confusing to know which rules or definitions apply. Know that our specialists are ready to answers your questions and help you be confident when it comes to understanding your tax return.
Legal Disclaimer: This post contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information. This information was current at time of posting; we are not responsible for updating this or any blog post/article for subsequent changes in the law or its interpretation.
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