A Guide to Understanding Capital Gains Tax

Capital gains are what you make on investments you sell (stocks, real estate, etc), by subtracting your basis (what you paid for it) from your sale price (the net additional amount you get); the longer you’ve held the asset and other things, the higher your tax rate.

The tax act allows homeowners to defer realising up to $250,000 of household gains so long as the unit had been used as a primary residence for two out of the past five years.

Long-Term Gains

Any asset held for longer than a year and then sold generates taxable long-term capital gains, which are taxed at substantially lower rates than short-term gains (15 per cent, 20 per cent or 0 per cent, depending on your income bracket).

If you sell an asset in less than a year, that’s short-term gain produced at ordinary income-tax rates (10 per cent to 37 per cent depending on your taxpayer status). The longer you own an asset and develop it, the lower your tax rate.

Knowing the tax treatment of long-term versus short-term capital gains will also help save taxes through opportunely investing assets in tax-deferred vehicles such as an IRA or 401(k). Additionally, use retirement accounts as a hedge against paying any capital gains tax should you decide to sell your investments at some point in the future.

Short-Term Gains

Capital gains are the profits you make by selling an investment such as stock for more than what you paid for it (such as dividends), and they are treated similar to ordinary income such as salary or wages, and possibly subject to net investment income tax (NIIT) at 3.8 per cent for those over certain income thresholds.

Capital gains are the difference between what you sold an asset for and what you had to pay for it (or in the case of second-hand items, what you paid for it plus commissions, costs to improve the item, etc, on which your basis was computed; depreciation expenses that reduce your basis but don’t have to be repaid are called capital allowances). And capital losses indemnify you against losses you suffer on sales of capital assets. You can apply capital losses against your capital gains and, if you have a net loss, you might be able to apply the surplus against your other income and reduce your tax bill on that income.

Short‑term capital gain is taxed at your marginal tax rate, depending on your total income and filing status. But long‑term gain is taxed at lower, ‘special long‑term’ rates of 0 per cent, 15 per cent or 20 per cent, again depending on your total income and filing status. Knowing your brackets can help minimise taxes on investment income, if the asset sales can be delayed until later in the year. But because capital gains drop into the same bracket that regular earned income might have filled, consider deferring those asset sales if you find yourself in a higher bracket than you might otherwise have expected.

Depreciation

The ability to depreciate permitted businesses to write off the decline in value of property, month after month, year after year, reducing reported net income of a business – and thus the taxes due on this net income to tax authorities – by a substantial amount. Investment property such as stock in a company or bonds issued by a company, as well as real estate property, was eligible for this depreciation expense. So was tangible personal property such as office furniture and fixtures, heavy equipment and cars, boats, planes and other vehicles. No wonder some crafty promoters distributed brochures to their customers congratulating them for inventing material. 12. Property Used in Rental Property Was Also Eligible for Depreciation As if the new rules for depreciation were not enough, businesses could write off rental-property costs as well.

The amount of depreciation on an asset is based on its original cost. The asset’s useful life is the period of time taken to amortise the asset’s cost or how many years it’s expected to be used. Salvage value represents an asset’s approximate value once it’s no longer useful in generating income for your business. Annual depreciation expenses are calculated based on these values, and are a vital part of any small business owner’s recordkeeping process. Accurately calculating your depreciation expenses will help you on your road to success. The IRS provides several depreciation methods for businesses to choose from. Some of these depreciation options also offer accelerated depreciation on certain types of assets; selective accrual depreciation is one of those methods. Taking advantage of selective accrual depreciation for your short-lived assets (such as electronics or equipment) might not show a substantial tax savings but will add to your cash flow initially. So, when figuring out which is the best approach for you and your business, it is always best to discuss it with your tax professional. He or she can let you know which depreciation method is going to be best for you to use.

Tax Rates

Whenever you sell an investment such as a stock or a piece of real estate, you have to pay capital gains tax. This depends on how long you held it, as well as your income level (as taxes have different rates, depending on which state you live in). The vast majority of people save and invest using tax-advantaged accounts – 401(k)s, IRAs, and 529 accounts – that ensure your earned income is taxed only upon entry (Roth accounts) or exit (traditional accounts).

Taxpayers who file for the 2023-2024 tax years will be subject to a 0 per cent rate on capital gains if the total income from all sources (taxable income) remains below certain thresholds, while the tax rate increases to 15 per cent if total taxable earnings surpass those levels. Moreover, a 28 per cent special sales tax would be in effect when an investor buys qualified small business stocks (QSBS) to invest in. The 28 per cent special sales tax would also be applicable when an individual purchases collectibles to sell in the future. Another taxes that applies when an investor sells investment properties after depreciating it under 1250 is the 25 per cent capital gains rate.