What is an example of Capital gains tax?

Answer 1

Capital Gain is what occurs when you purchase an asset and that asset increases in value. For example, you bought stock in a company at $10.00 per share and you purchased 100 shares giving you a total investment of $10.00 X 100 shares equals $1000.00 We'll disregard brokerage fees for this example.

The stock increases in value. The increase in value is your Capital Gain but you don't have to pay taxes on it until you actually sell the stock. So, say you hold the stock for a couple of years and then decide to sell it. The stock has increased in value to $15.00 per share. So your 100 shares is now worth $1500.00.

When you figure out the tax you'll have to pay on that Capital Gain, you deduct your initial investment of $1000.00 from the $1500.00 for a net gain of $500.00. Since it's a Capital Gain, you're only taxed at the 50% rate. Therefore you have to pay the government the tax on $250.00 of your Capital Gain.

Gains and losses from capital assets are treated differently than other income.

Most income, like a wage or from employment, are taxed as "ordinary income". In a business, sales of non-capital assets, such as inventory or stock of goods held for sale, or income from services rendered, are also taxed as ordinary income. (And the rates vary in an increasing scale as the total amount of income increases, to a maximum in the US now of @38%)

The United States system defines a capital asset by exclusion (meaning it is not as specified as it is not other things that are specified). Capital assets include all assets exceptinventory of supplies or property held for sale (including subdivided real estate), depreciable property used in a business, accounts or notes receivable, certain commodities derivatives and hedging items, and certain copyrights and similar property held by the creator of the property. Capital assets generally include those assets outside the daily scope of business operations, such as investment or personal assets. For individuals this generally simply means something that you have made an investment in, rather than actively engaging in some form of work for. The most common being purchasing stock as an investment.

Only the amount you receive above what you have invested is Capital income. The return of your investment is just a return of your money and not a source of income.

Of course, it is possible that you receive less than you invest. The amount less is a Capital Loss.

With some specific exceptions (beyond this), Capital Losses and Gains are independent of Ordinary Income and can only be used to offset each other. (There are considerations for how long the investment was held also - causing a sub-category of Long and Short Term capital gains and losses). Currently, in the US, Short term capital gains or losses are given the same tax rate the same as the taxpayers Ordinary income. (Which again varies person to person).

Long Term Capital Gains are taxed at a flat 15% (very preferential) rate for anyone whose tax rate on ordinary income would be higher than that. 9If their ordinary rate is lower (they are in a low tax bracket for all income), then there is no tax applied to capital gains.

Consider however, if you have a LOSS you would prefer it be a short term one (which has the higher rate, as the loss works as a tax BENEFIT, offsetting what you would owe on Gains/income, so the higher rate would provide more of a benefit.

Examples:

1) Invest $1,000 & sell next week for $1500. $1,000 return of investment (not taxed), $500 Short Term capital gain - taxable at your ordinary income tax bracket rate (say 35%) for $175.

2) Or Invest $1,000 & sell in 2 years for $1500. $1,000 return of investment (not taxed), $500 Long Term Capital Gain - taxable at a flat 15% for $75.

3) Invest $1,000 & sell next week for $500. $500 return of investment (not taxed). $500 Short Term capital loss - able to be used to offset income in example #1 above (making net income between the 2 deals 0 - and saving the $175 tax you would have paid). There are situations where this loss may even be used against your other types of (ordinary) income.

4) Or Invest $1,000 & sell in 2 years for $500. $500 return of investment (not taxed), $500 Long Term Capital Loss - able to be used to offset income in example #2 above (making net income between the 2 deals 0 - and saving the $75 tax you would have paid). There are situations where this loss too may even be used against your other types of (ordinary) income.