Capital Gains and Losses
An understanding of capital gains and losses is extremely important in tax planning. Capital gains and losses are due solely to the sale or exchange of capital assets. With certain exceptions, capital assets property you own and use for personal purpose, pleasure, or investment. Examples include stock and bonds; personal residence; personal automobiles; household furnishings; collectibles, such as coins, stamps, jewelry, gold, or art; and land held for investment.
You realize a capital gain when the property is sold or exchanged for an amount that exceeds your adjusted cost basis in the property (your cost increased or decreased by certain allowable transactions). The rules determining your cost basis complex and depend on the type of property acquired, especially common stocks. Example Tanya purchased 100 shares of common stock at $39 a share and paid a broker’s commission of $100. Her cost basis is $4000. The stock is sold two years later at $102 a share less a commission of $200. Tanya has a long-term capital gain of $6000.
Capital gains and losses are divided into two categories: short-term and long-term. Short-term capital gain (or loss) results from the sale or exchange of assets held for one year or less. Long-term capital gains (or loss) result from the sale or exchange of assets held for more than one year. This distinction is important since long-term gains are taxed at a lower rate. Long-term capital gains (at the time of this writing) are taxed at maximum rate of 28 percent even if you have ordinary income tax at a higher rate of 28 percent even if you have ordinary income taxed at a higher rate. In determining the amount of tax, short-term transactions and long-term transactions are calculated separately. Short-term capital gains are netted against short-term capital losses, which results in a net short-term capital gain (loss).
Likewise, long-term capital gains are netted against long-term capital losses, which results in a net long-term capital gain (or loss). The two resulting figures are then combined to determine if you have a net capital gain (or loss) for the current tax year. The net capital gain (or loss) is subject to a number of rules for purposes of determining the amount of tax.
State and local taxes
In addition to the federal income tax, effective tax planning requires an understanding of other types of taxes. Most states have a state income tax as a major source of revenue.