Many assets increase in value over a period of time and this process is called capital appreciation. When these assets are sold, the surplus that is realized over and above the cost of the asset is called a capital gain. If I buy a house for $ 50,000 and then sell it later for $ 100,000, the surplus of $ 50,000 that I receive becomes my capital gain. If the gap between purchase and sale is less than one year, it is called a short term capital gain. If the gap is more than one year, it is called a long term capital gain. Conversely if I realize less than what I paid, the result is a capital loss. Under US tax statutes, capital gains and losses up to be reported to the IRS on my tax returns and capital gains tax if applicable has got to be paid.
Short term capital gains are taxed at the same tax rate as regular income. In the case of long term capital gains, since the government wishes to encourage investment and entrepreneurship, a preferential tax rate is applied. In the calculation of taxable capital gains, the cost basis is used rather than the actual purchase price. For instance in the case of real estate, the cost basis is an adjustment of the purchase price that takes into account factors such as fees , property taxes and the cost of improvements. This means that the taxable gain would be less than the surplus over the purchase price that is realized.
Under IRS regulation you are required to calculate your long-term capital gains on parts II and III of schedule D. which you would need to file every year along with form 1040 if you are an individual taxpayer. Here is a guide as to what you should do to keep track of your capital gains:
-make a record of every event relating to capital gains immediately as it happens. This should include documentation and full particulars of every purchase and sale, the adjustments to arrive at the basic cost and the capital gains or losses realized.
-separate all the data relating to long-term investments (i.e. more than one year) and transfer to a separate database or spreadsheet created for the purpose. Enter a brief description of the investment item along with sale price, cost and dates of sale and purchase
-reduce the gross sale price that you receive by the expenses you are allowed to set off against it such as advertising or brokers’ commissions and figure out the price for the purpose of your tax calculation
-subtract the cost basis or any other basis that you are using from the net sale price to arrive at your capital gain
-at the time of filing your 1040, you can transfer the data from the spreadsheet to schedule D.
One of the major criticisms of long-term capital gains taxation is that it does not allow any adjustments for inflation. We are all aware that inflation erodes the purchasing power of our dollars and that a capital gain reported and taxed may actually be a loss because of inflation and the reduced purchasing power of the dollar. Her however, we will have to do with the tax laws as they are and hope that someday the government will allow the indexing of capital gains to take into account the erosion in the purchasing power.
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