Here’s everything you need to know about capital gains, how it works, ways to reduce capital gains tax and more.
Capital Gain: How Does Capital Gain Tax Work?
The term capital gain is a profit earned from selling an asset/investment.
A tax on the profit realized by individuals and corporations from the sale of non-inventory assets such as stocks, bonds, real estate, property and precious metals is called capital gains tax.
Say for example you bought 50 shares of ABC stocks at £30 per share and sold them more than a year later for £70 per share and are taxed at 20% depending on your income tax band. Bear in mind that the currency is in pound (£) because it is calculated according to UK tax rate and tax percentage may vary per country. Expressed as an equation, that means:
In this example, £400 of your profit will go to the government and the profit after tax is £1,600.
Capital gain is not merely limited to stocks, mutual funds and bonds. This can also apply to collectibles, real estate and anything else that can be considered as an investment.
Realized Gain Vs. Unrealized Gain
Knowing the difference between realized gain and unrealized gain is important.
A realized gain is when the selling price is higher than the original purchase price. Capital gains are taxed only when sold and realized. Investments that have not yet been sold and just potential profits, are considered as unrealized gains.
Qualifying Assets For Capital Gains Treatment
Capital gains treatments are taxes being imposed on assets but not every capital asset that you own will qualify for capital gains treatment including: business inventory, depreciable business property and non-capital assets such as musical or artistic composition, letter and memorandum.
Understanding Long-term And Short-term Capital Gains
Assets must be held for more than a year to qualify for the most favorable long-term capital gains rates.
Any gains on assets that have been held for a year or less are short term capital gains.
Over the years, tax brackets have changed. Capital gains rates are 0%, 20%, 40% and 45% depending on one’s tax bracket. Rates are much lower than the ordinary tax rate.
|Band||Taxable Income||Tax Rate|
|Personal Allowance||Up to €12,500||0%|
|Basic Rate||€12,501 to €50,000||20%|
|Higher Rate||€50,001 to €150,000||40%|
|Additional Rate||over €150,000||45%|
Two types of capital gain taxes that you may encounter:
- On collectibles, 28% rate are being taxed on artworks, stamp collections and etc. Rates may vary per country.
- You can sell your home and be exempt from capital gains tax, Based on Internal Revenue Service (IRS) you must have occupied the residence for at least two of the last five years.
Reducing Capital Gains Tax
- Long term Investment
- Investing money through a retirement plan
- Taking advantage on an investment loss by decreasing the tax on your gains on other investments
- Watching holding periods
- Determining cost basis