Investing – be it in short-term assets or long-term resources - has tax implications, some of which could cause you to send more than a third of the investment income to the taxman. If taxation and fiscal legalese are not your strong suit, reach out to a professional who can look at your fiscal situation and help decode what kind of capital gains and losses you are subject to, as well as tax benefits you may be entitled to. These specialists include certified public accountants, fiscal attorneys, enrolled agents and tax accountants.
What Are Capital Gains and Losses?
The notions of capital gain and loss interrelate with the concept of financial product, especially the pastiche of investment products you would discuss whenever you meet with your financial adviser. These products include stocks, bonds, hybrid assets, mutual funds and exchange traded funds, also known as ETF.
You make a capital gain if you hold one or all of the above assets for more than 365 days and sell it at a profit. You incur a loss if the reverse scenario is true. For example, assume you bought 1,000 shares of Company A at $10 apiece. After five years, the share's value rises to $15. If you sell your holdings, you would generate a stock capital gain of $5 per share, or $5,000 in total. The same analytical approach applies to your other assets, say, gardening equipment, mortgage-free home and lien-free car.
Do They Have Fiscal Implications?
Yes. Congress and the Internal Revenue Service have adopted a somewhat generous view of capital gains – and losses, for that matter. You pay a 15% tax rate on money you make on the sale of investment assets you've held for more than one year. You can carry over to future years the short-term capital losses you are unable to claim in a specific year.
The IRS limits capital loss deductions to a specific threshold per year, depending on your income and tax brackets. Unlike the capital tax rate, which is fixed at 15% at the moment, tax rates for ordinary employment – that is, you and I going to work, taking care of our 9-to-5 duties – fluctuate from 10% to 39.99%, depending on income levels.
A friend of mine who has managed his own investment portfolio for years says it's always best to let your money work for you than using physical or intellectual force to advance professionally and socially – an assessment that seems to be true, considering that the taxman levies lower rates on capital gains and higher rates on ordinary income.
What Are Capital Assets – And Why Do They Matter?
When business observers and accountants talk about a company's capital assets, they don't necessary allude to financial products with a maturity of one year or more. They refer to things like property, plants, computers, production equipment and the hodgepodge of gadgets that modern-day technology floods us with. In accounting lexicon, terms like "fixed asset," "tangible resource," "capital asset" and "long-term resource" are interchangeable.
Capital assets matter because banks and insurance companies, among other institutions, invariably take these resources into account when evaluating your credit or insurance (especially life insurance) application. For example, they would calculate your net worth – your total assets minus total liabilities – to figure out where you fall on the income spectrum.
Alternatively, your insurance agent might want to determine your liquidity level, meaning what assets you can quickly sell to get some cash if you faced an economic emergency. Capital assets, especially those that are customized for something specific, often don't find a buyer quickly and may entail a convoluted process requiring regulatory and lender approvals – think of trying to sell your house versus the secondhand lawn mower you bought last summer, for example.
Accounting for Capital Gains and Losses
When preparing your personal financial statements, report capital gains and losses in your statement of profit and loss. Finance people also use terms like "P&L," "income statement" and "report on revenue and expenses" when referring to this accounting data summary. Lenders and insurance companies often ask you to provide this report to verify things like income and net surplus and determine how much you already are paying on fixed expenses, like loan remittances. By flowing through your P&L, capital gains and losses also affect your net worth.
Capital gains generate cash, a short-term asset, which increases your overall resources. By contrast, capital losses reduce your net worth because they create a dent in your P&L. Talk to your tax accountant to learn more about the best way to calculate and report your capital gains and losses because the IRS may want to reconcile your tax information with your financial data, typically to ensure consistency and completeness. Besides your P&L, other accounting reports affected by capital gains and losses include balance sheets and statements of cash flows.
You make a capital gain if you sell an asset you have held for more than one year, and a loss if the reverse is true. You pay a lower rate, currently 15%, on your capital gain, and you can deduct a capital loss over several years, depending on your fiscal situation and prevailing tax laws.