A capital gain or loss interrelates with the concept of "capital asset," the kind of resource you use or form which you expect to benefit over 12 months or more. In other words, any resource you hold for more than one year before selling it qualifies as a capital asset. Examples include your mortgage-free house, gardening equipment, and lien-free car along with investments as diverse as stocks, mutual funds, and bonds. Totally understanding taxes and their rules can be a challenge but understanding capital gains and losses can help you navigate tax laws adeptly and minimize your overall fiscal debt.
How Do I Calculate the Basis of Property Received as a Gift?
To calculate the basis of property bequeathed to you by, say, Aunt Sallie, you need to figure out three specific amounts:
- Gift tax paid on the property,
- The asset's fair market value at the time you received it, and
- The property's adjusted basis to the donor before he or she transferred it to you.
If the donor's adjusted basis is less than or equal to the property's fair market value, then your basis is the donor's adjusted basis. "Basis" simply means how much the property is worth to you, which is also the value that the taxman ascribes to the asset. You also must increase your basis by the gift tax paid by the donor as a result of a higher value of the property over time.
Do I Pay Taxes After Selling My Home?
The short answer to that question is "yes," subject to certain conditions. Before talking about taxes and capital gain, it is important to accurately calculate the adjusted basis of your house. This equals the cost of the property – that is, the mortgage you obtained to finance it – plus interest as well as improvements you made over the years. If you sell your house and receive more money than you invested in the property – meaning your adjusted basis – that extra cash is considered a capital gain and typically is taxable. You normally would receive Form 1099-S (PDF) at the end of the year in which you sold your abode, and you must use that form when filing your tax return.
I Sold My Second Residence: Should I Report the Transaction?
You must report the sale of your second residence on two forms: Schedule D (Form 1040) (PDF), Capital Gains and Losses, and Form 8949 (PDF), Sales and Other Dispositions of Capital Assets. The IRS considers your second residence, say, a vacation home, as a capital asset, so you must use both forms to report everything from exchange to sale of the residence.
How Do I Calculate the Cost Basis of Stock Sold?
If you own stocks, your cost basis normally is the price you paid for the shares plus additional expenses like brokerage fees and commissions. If someone transfers the stocks to you as a gift, your cost basis is the donor's adjusted basis or the fair market value of the shares. "Fair market value" means how much money a willing buyer would disburse, and a willing seller would accept, for a specific product or service. Think of your neighbor trying to sell you his used lawn mower; before buying it or even agreeing on a price, you certainly would ask around and do some research online to have a price range in mind.
To figure out the cost basis of stock you sold, just go back and identify how much you paid for it. That sounds easy enough and certainly would apply to your situation if you had a small portfolio. But if you have a large portfolio of several securities, use evaluation techniques like FIFO (first in, first out) or moving average to calculate the cost basis of shares sold.
Do I Pay Taxes after A Stock Split?
You don't have to pay taxes after a stock split because a split simply means a company is issuing additional shares to investors while adjusting the per-share value according to the split ratio. There is no gain or loss situation here, so you don't have to report any income to the Internal Revenue Service and your state's fiscal authorities. For example, you own 1,000 shares of Company A, and the per-share value is $5. After a 5-to-1 stock split, you will own 5,000 shares of Company A, but the per-share worth now is $1. Note that in the pre- and post-stock split scenarios, the overall value of your portfolio does not change and remains $5,000.
How to Figure Out the Average Basis of Mutual Funds?
To calculate the average basis of mutual funds you sold or want to sell, add up the cost of shares in the mutual funds and divide that sum by the number of shares owned. Simple as that! For example, say you initiated the following transactions during the previous year:
January 2: Bought 500 shares of Mutual Fund A at $2 apiece. March 7: Bought 1,000 shares of Mutual Fund A at $3 apiece. June 15: Bought 1,500 shares of Mutual Fund A at $4 apiece. November 1: Bought 2,000 shares of Mutual Fund A at $5 apiece. December 30: Sold 4,000 shares of Mutual Fund A at $6 apiece.
Let's figure out the average basis of the mutual funds you sold at the end of the year:
1, Total cost of shares purchased is computed as follows:
500 shares x $2 = $1,000
1,000 shares x $3 = $3,000
1,500 shares x $4 = $6,000
2,000 shares x $5 = $10,000
Total cost = $20,000
2, Number of shares sold = 4,000
3, Average basis of shares of Mutual Fund A sold = $20,000 divided by 4,000 = $5
I Haven't Sold My Mutual Funds: Do I Report Capital Gains?
You may still need to report capital gains on mutual funds you own even if you do not sell your shares in the mutual funds. A mutual fund company generally makes money by buying and selling its underlying securities – think stocks, bonds, Treasury bonds – at a gain. Capital gains – and losses, for that matter – earned by the mutual fund company gets passed on to you. So you must report that income as a long-term capital gain even if you bought shares in the mutual fund today.
The bottom line is that the concept of capital asset does not pertain to the length of time you have held a specific mutual fund share, but rather relates to how long the mutual fund company has held the underlying investment.
Can I Deduct the Loss on My Home's Sale?
You cannot deduct the loss on the sale of a house you kept as your primary residence at the time of sale. For more information, read Internal Revenue Service's Tax Topic 409, Capital Gains and Losses and Publication 523, Selling Your Home.
Can I Report Losses on Worthless Stock?
You can report losses on worthless stock as capital losses on Form 8949 (PDF), Part I, line 1, or Part II, line 3. Determine which option applies to your situation and don't forget to mention that this is a worthless investment deduction by indicating "Worthless" in the relevant section of Form 8949.
You would normally treat worthless shares as capital losses because the IRS considers – and you also should consider – that you would never recoup the money you initially doled out to buy the shares. Note, however, that worthless shares are not treated as a deduction of bad debt, which is money a customer owes but cannot pay and that a vendor must, therefore, write off and deduct as a loss.
When it comes to tax matters pertaining to capital gains and losses, the most important thing to know is the adjusted basis or cost of the investment or property you are selling. You can use various techniques, including FIFO and average basis, to determine the worth of an asset sold. If you have more questions about capital items and how they could affect your tax situation, seek the expertise of a professional. Experts such as certified public accountants, tax attorneys, fiscal accountants, and enrolled agents can help you decipher IRS laws on capital losses and gains.