There are many tax terms that can get confusing if you’re not a tax expert. Basically, capital gains tax is applied to the increase in investment value. In order to understand how the tax is applied you must first know what a capital gain is.
- Capital Gain – the resulting amount when the purchase price of an investment (known as the basis) is subtracted from the price the asset is sold for, when the sale price is greater than the basis.
If the purchase price is higher than the sale price, the result is a capital loss, and tax is not owed.
You buy 50 shares of a company for $2 each. After six months, the price per share increases to $4 each. Your investment value has changed from $100 to $200, resulting in a capital gain of $100 if you were to sell the asset.
Short vs. Long Term
If you chose to sell the investment in the aforementioned example after only six months, it is considered a short-term capital gain. You will be taxed at the regular income tax rate, as opposed to a lower long-term capital gain tax rate. Long-term capital gains are considered after a year or more of holding the asset at the gain price.
How to Report
You report capital gains using a Schedule D, and the tax rate is determined depending on the term of the capital gain, and in some cases the type of asset you sold.