Capital Gains

What are capital gains?

Capital gains incur when you sell an asset for more than you paid for it. These assets can be investments like stocks and real estate or personal items like a boat or furniture. The profit you make is the capital gain, and it might be subject to taxes by the IRS.

Example of capital gains

Let's say Sarah buys a piece of artwork for $2,000 in January 2019. In January 2021, she sells it for $5,000. Here’s how you figure out her capital gain:

  • Purchase Price: $2,000
  • Sale Price: $5,000
  • Capital Gain: $5,000 - $2,000 = $3,000

Since Sarah held the artwork for more than a year, her gain is considered a long-term capital gain. If Sarah is in the 15% long-term capital gains tax bracket, she would owe $450 in taxes on her $3,000 profit ($3,000 x 0.15).

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Net capital gain

The IRS defines net capital gain as the difference between your total long-term gains and your short-term losses, plus any previous losses you’ve carried over. Net capital gains are often taxed at a lower rate than regular income.

Types of capital gains

There are two types of capital gains:

  1. Short-term capital gains: Gains from selling assets you’ve owned for one year or less.
  2. Long-term capital gains: Gains from selling assets you’ve owned for more than one year.

Fun fact about capital gains

Did you know that you can avoid paying capital gains tax if you reinvest your profits into a Qualified Opportunity Fund (QOF) within the span of 180 days. This special provision, part of the Tax Cuts and Jobs Act of 2017, is created to encourage investment in economically distressed areas known as Opportunity Zones. 

So, not only can you defer taxes, but you also contribute to community development.

In conclusion

Capital gains are the profits/earning you make from selling assets, and they can be a great way to grow your wealth. Learning the difference between short-term and long-term gains and knowing how they’re taxed, can help you make smarter investment decisions.

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TL;DR

  • Capital gains are profits from selling assets for more than you paid for them.
  • They can apply to both personal items and investments.
  • Gains are classified as short-term (held for less than a year) or long-term (held for more than a year).
  • Unrealised gains and losses are not taxed until the asset is sold.
  • Capital losses, when an asset sells for less than its purchase price, can offset gains and reduce your tax liability.

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