Now, we will talk about yet another form of taxing your income, but one you could hardly expect – Capital Gains Tax. Firstly, while selling an asset (property, stocks, bonds, collectibles) you can earn money thanks to the growth of its price. The difference between selling price and the initial cost price is the capital gain. When the government takes some part of it, it is Capital Gains Tax.
It is rather easy to calculate it. To begin with, you should take the price of selling the asset and subtract from it the initial cost price and the profit is yours. If you buy Tesla shares for one hundred dollars and sell them for one hundred and fifty dollars, your capital gain is equal to fifty dollars.
However, you need to bear in mind the “allowable costs” which reduce your profit. Allowable costs can be broker fees, advertising costs while selling the property etc. In this way, you can reduce your taxable income from the capital gain as much as possible.
Secondly, the tax rate depends on the period of holding the asset. In case it is less than a year, the profit becomes a short-term capital gain which is usually taxed by income tax rate. However, if you held it more than one year, it is a long-term capital gain which is usually taxed between zero and twenty percent depending on your income. 📈
One of the biggest reliefs for homeowners is primary residence exclusion. If you sell the house where you really live, you can exclude some amount of the gain from this tax. In the United States, if you are single, you can exclude two hundred and fifty thousand dollars of the gain. Most of normal sales of houses give you zero tax liability. It is one of those times when the tax legislation does not screw you.
You should also know about capital losses since every investor sometimes makes mistakes. If you sell the asset for less than the initial cost price, it is capital loss. The tax system allows you to offset capital losses with capital gains. Thus, if you made a thousand dollars from Apple stock and lost a thousand dollars from crypto trading, you pay tax on zero gain. Such a strategy is called tax-loss harvesting.
The last point you should know is that Capital Gains Tax is applied after the selling of the asset. While the price of a stock rises, you have unrealized gains which you are not obliged to pay taxes for. This is the reason why many people say “you don’t lose until you sell.” Of course, it works the same for the tax bill – you pay taxes after the selling.
The most important measure which you can take – keep good records. All receipts, emails, and statements related to your investments should be kept. When the tax season comes, you won’t waste your time finding the email with your purchase to see the price of the asset. Keeping track of the dates and prices of buying with the help of the spreadsheet will save you much time and headaches.
In case you find the process too complicated for yourself, there is no need to play a hero. You can use special tax software like TurboTax or H&R Block. You will learn the needed forms and fill them easily. And in case of big amounts and transactions with real estate, you can hire a Certified Public Accountant (CPA). His help will cost you several hundred dollars, but it is worth of it. 😅