Long-Term Capital Gains or Losses - Explained
What are Long-Term Capital Gains or Losses?
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Table of ContentsWhat are Long-Term Capital Gain or Loss?How Does Long-Term Capital Gain or Losses Work?Holding Period CalculationHow to Determine a Long-Term Gains or LossExample of Long-Term Capital Gain or LossConclusion Academic Research on Long-Term Capital Gain or Loss
What are Long-Term Capital Gain or Loss?
A long-term capital gain or loss is a company's profit or loss that originates from the sales of a long-time investment. The American tax law defines long-term capital gain as the profit the company receives after selling capital assets such as bonds, mutual funds, stocks, and real estate. The same tax law defines a long-term capital loss as a loss generating from sales of property.
How Does Long-Term Capital Gain or Losses Work?
A company can calculate its capital gain or loss on a cost basis, which is all the amount that the company uses to make the purchase. The cost basis of an asset may increase or decrease depending on whether the value of the property increases or decreases. The value of a property can increase through; site improvement on public infrastructure, capital improvements, and renovations of the damaged property. The company then subtracts the cost basis from the net sales to find the capital gain or loss. The purchasing price of an asset includes the following fees;
- Legal and accounting charges
- Excise taxes
- Real estate taxes, if the property is a building
- Revenue stamps, and
- Settlement fees where applicable.
Holding Period Calculation
Every asset has a holding period, which is often the time that the company preserves the asset before selling it. When calculating the holding period, the company should omit the purchasing date, as it does not count, and include the selling date. Assuming a company buys stocks on September 19th, 2019, then the holding period will start on September 20th, 2019. Therefore, if the company preserves the bonds up to one year since the purchase, the gains on the stocks are long-term and are taxable.
How to Determine a Long-Term Gains or Loss
A company will determine its long-term gains or loss by finding the difference between the selling price and the buying price of the assets. The company, as a taxpayer, should report its total capital gains every year as it files its tax returns because the IRS treats all gains as taxable income. Long-term tax rates are often lower than short-term tax rates because it is under the regulation of the IRS. IRS assigns a tax rate as high as 37% on short-term rates, while long-term gains receive a tax rate of between 0% to 20%. Taxpayers in the low-income bracket of 10% to 15% have a long-term gain rate of 0%. Short-term capital gains have tax rates in the same bracket as your salary, and IRS may sometimes include an additional medical care tax of 3.8%. The tax law has a few exceptions;
- IRS assigns a tax rate of 28% on long-term gains from collectibles like antiques, precious gems, fine arts, stamps, and coins unless the taxpayer is a low-income earner.
- Real estate property is subject to depreciation, which means that your cost basis also reduces. Depreciation deductions also increase the profits from the property, and the IRS assigns them a tax rate of 25%, except when the taxpayer is in the 10% to 15% bracket.
- Long-term gains from assets that children between nineteen to twenty four sell are subject to tax, as they may not qualify for the 0% tax rate.
Note that a company can deduct its long-term losses from its long-term capital gains, though there is a limit on the mount. IRS allows a company to deduct capital losses of up to 3,000$ from any of its capital gains, including interest. If the company is unable to deduct all the losses in that financial year, it can carry forward the balance to the following financial years.
Example of Long-Term Capital Gain or Loss
Assume you buy 200 shares of a Company ABC for $1 per share. In four months, the price of each share increases to $5. It will mean that the value of your shares will rise from $200 to $1000, with a capital gain of $800. As a taxpayer, you report the capital gains on the IRS schedule, so that it can allocate tax rates on the gains. The tax rates will be different depending on whether the gains are long-term or short-term. If you decide to sell the shares of Company ABC after 2 months, the capital gain will be short-term. The gains will be charged the same tax rate as your ordinary salary tax rate. But, if you wait after one or more years to sell the shares, the $800 profits will be counted as long-term capital gains.
Low tax rates on long-term capital gains encourage investors to undertake long-term investment projects. Although, an investor may urgently need to sell his/her investments before a year, impacting high tax rates on capital gains. Investors should find advice from tax professionals to understand how capital gains and losses affect their decisions on various investments. Long-term capital losses may sometimes balance out with all or part of the investors capital gains, even though there is an offset limit.