Understanding Capital Gains and Losses
Two terms that every taxpayer and every investor need to be familiar with as capital gains and capital losses. When it comes to taxes, the rules are fairly straightforward and easy to understand. If you have a capital gain on an investment, you typically will have to pay taxes on that gain. If you lose money on an investment, you may be entitled to write off at least some of that loss.
Virtually everything that is owned is a capital asset. Capital can consist of everything from stocks and bonds to mutual funds and the roof over your head. There are special rules for capital gains as they apply to a principal residence, so those considering the sale of a home should be sure to check with their accountant or tax preparer.
When it comes to stocks and other capital assets, the taxpayer is generally required to pay tax on the difference between the selling price and the original purchase price. For instance, if you purchased a block of stock for $5,000 and sold it later for $10,000 you would be required to pay taxes on the resulting $5,000 capital gain. That capital gain would be reported on Schedule D of the 1040 tax return.
Capital gains and losses are further broken down into long term and short term varieties. Assets held for less than a year are taxed at the short term capital gain rate, while assets held for longer than a year are subject to the more favorable long term capital gains rate.
While the government generally wants a piece of every capital gain, it is not as eager to share in capital losses incurred by taxpayers. Taxpayers are entitled to deduct losses of only $3,000 per year, regardless of the amount of the actual loss. As always, it is a good idea to check with a qualified tax preparer or accountant when determining your true level of capital gain liability.
Dealing with taxes on capital gains may not be any fun, but it sure beats the alternative. Ask any investor if he or she would rather have a capital gain and a tax or a capital loss, and the answer will quickly become clear.