Definition of Capital Gains Tax (CGT)
Capital Gains Tax (CGT) refers to the tax on the profit realized from the sale of a non-inventory asset. This asset could be real estate, stocks, bonds, or another type of investment. CGT is calculated on the difference between the asset’s selling price and the original purchase price, often referred to as the basis. The tax rate can vary based on the holding period of the asset and the taxpayer’s tax bracket.
Examples
- Real Estate: John bought a house for $200,000 and sold it for $300,000. The capital gain is $100,000, and CGT is calculated on this gain.
- Stock Market: Sarah purchased shares for $5,000 and later sold them for $7,000. The $2,000 profit is subject to CGT.
- Bonds: Michael bought a bond for $10,000 and sold it after a few years for $12,000. The $2,000 profit is the capital gain that can be taxed.
Frequently Asked Questions
What is the difference between long-term and short-term capital gains?
Answer: Long-term capital gains apply to assets held for more than one year and typically benefit from lower tax rates. Short-term capital gains apply to assets held for less than one year and are taxed at the individual’s ordinary income tax rate.
Is there a way to reduce capital gains tax liability?
Answer: Yes, strategies such as tax-loss harvesting, using tax-deferred accounts, reinvesting in opportunity zones, and taking advantage of primary residence exclusions can help reduce CGT liability.
Do inherited assets incur capital gains tax?
Answer: Inherited assets receive a “step-up” in basis to their market value at the date of the original owner’s death, which often reduces the capital gain and thereby the CGT when sold by the inheritor.
Are there any exemptions for capital gains tax?
Answer: Certain exemptions apply, such as the primary residence exclusion, which allows single filers to exclude up to $250,000 of gains ($500,000 for married couples) from the sale of their primary residence under specific conditions.
How are capital gains reported on taxes?
Answer: Capital gains are reported on Schedule D (Form 1040) for individuals in the U.S. along with the Supplemental Income and Loss form (Schedule E) if applicable.
Related Terms
- Basis: The original value of an asset for tax purposes, used to determine capital gain or loss upon its sale.
- Tax-Loss Harvesting: A strategy to sell securities at a loss to offset a capital gains tax liability.
- Step-Up in Basis: The readjustment of the value of an inherited asset for tax purposes upon the inheritor’s acquisition.
- Ordinary Income Tax Rate: The regular rate at which an individual’s earnings are taxed.
Online References
- IRS Capital Gains and Losses: https://www.irs.gov/taxtopics/tc409
- Investopedia: Capital Gains Tax: https://www.investopedia.com/terms/c/capital_gains_tax.asp
- Kiplinger: Strategies to Reduce Capital Gains Tax: https://www.kiplinger.com/taxes/capital-gains-taxes
Suggested Books for Further Studies
- “Tax-Free Wealth: How to Build Massive Wealth by Permanently Lowering Your Taxes” by Tom Wheelwright
- “J.K. Lasser’s Your Income Tax” by J.K. Lasser Institute
- “The Individual Investor’s Guide to Personal Tax Planning” by American Association of Individual Investors
- “The Tax and Legal Playbook” by Mark J. Kohler
Accounting Basics: “Capital Gains Tax (CGT)” Fundamentals Quiz
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