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Understanding Capital Gains And Losses

If you have investments, you also need to understand capital gains and losses. But exactly what types of investments do we refer to? Well it could be stocks, bonds, a vacation house, or even a stamp collection. A capital gain is profit that results from selling your capital assets at a higher price of what you paid when you bought that investment. If the price of the capital asset has declined instead of appreciated, this is called a capital loss.

When understanding capital gains and losses, you also need to understand an important term: basis. Basis is the original cost of property adjusted for factors such as depreciation. In other words, basis refers to the amount of your investment in an asset. You will need to calculate both your initial basis and adjusted basis in the asset. Initial basis commonly equals the cost of you asset. However there could be some special cases where the cost differs from the initial basis, for example if you did not purchase an asset but rather received it as inheritance. Adjust basis is the cost of an asset plus the value of any expenditures for improvements minus any depreciation taken. For example, if you buy a house for $80,000, the initial basis in the house will be $80,000. If you later improve your home by constructing a second floor for $20,000, your adjusted basis in the house will be $100,000. You should be aware of which items increase the basis of your asset, and which items decrease the basis of your asset. For more information check IRS Publication 551.

If after selling your assets you end up with a capital gain, special capital gains tax rates may apply. These rates may be lower than ordinary income tax rates. Basically, to calculate your capital gain or loss, simply subtract the amount that you realize on the sale of your asset minus your adjusted basis in the asset. If you sell your asset to a higher amount than your adjust basis, then you have a capital gain. You'll need to calculate your short-term and long-term capital gains and losses in Schedule D of your income tax return, and figure the tax due, if any. You'll need to know your adjusted basis and the amount realized from each sale, your holding period, your marginal income tax bracket, and the type of assets involved. For more information on this see IRS Publication 544. If things get too complicated, remember that you can consult the IRS publications, or seek the help of an accountant.