Taxes and Capital Gains

Capital Gains When you sell or exchange a capital asset such as stocks, bonds or real estate, and the transaction exceeds your purchase price, you would have made a capital gain. Real assets such as property, financial assets such as shares or bonds, and intangible assets such as goodwill can all make capital gains. Several states enforce a capital gain tax on individuals or corporations, although reprieves may be available to some exempt investments such as large amounts of common stock holdings, as an incentive to free enterprise, or to make up for inflation.

In 2003 the tax rate on eligible dividends and capital gains was reduced to 15% and 5% in the lowest two income brackets, and this rate will expire in 2010 as a result of the Tax Reconciliation Act signed into law by President George W. Bush on May 17, 2006. Unlike other countries, US citizens must pay taxes on capital gains made on any investment worldwide, no matter where they reside.

The IRS offers these facts on capital gains:

• You must report capital gains and losses on Schedule D, then transfer them to line 13 of Form 1040
• Depending on how long you hold the property before you sell it, you can classify the capital gain as long- or short-term. Anything held for less than a year is considered short-term
• Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss
• The maximum capital gains rates are 5%, 15%, 25% and 28%
• Losses that exceed your capital gains are subtracted from other income on your tax return, up to an annual limit of $3,000.

Although the taxes you pay on capital gains can be painful, it is still a very good thing. The two main ways to reduce the tax you pay are to hold assets for more than one year and to allow investments to compound tax free in retirement-savings accounts. In this way you can protect your money from taxes and enjoy the benefits of compounding all at the same time.