You may have heard about the terms capital gains or capital gains taxes. It is often within the context of taxes or investments. But what is a capital gain and what does it mean for you?
First is the definition of capital. Capital is an economic concept that refers to anything that you can hold in your hand. Examples of these are furniture, a home, car, boat, baseball cards, antiques, stocks or other investments. Although we don’t think of stocks as a physical thing, it is possible to obtain a piece of paper (a certificate) that lets you hold your shares of stock in your hand. However, almost no one does this anymore.
What Happens To The Value Over Time
Next, the value of that physical thing can go up or it can go down. You can sell it for more or less than you paid for it. That difference between the price paid and the price when sold is called a capital gain (if it goes up) or a capital loss (if it goes down). If the value goes up and you sell it, that gain is like income to you – a profit.
It turns out that the Internal Revenue Service (IRS) also sees that gain as income. And it would like you to pay taxes on the amount of that gain. But the IRS charges different tax rates depending upon how long the item was kept before it was sold again. They charge a lower rate if it was held longer than a year, thus encouraging taxpayers to hang onto these capital items rather than just buying and selling quickly.
Realized Vs Unrealized Gains
There is another related concept to consider related to gains. If you buy something and the amount you could sell it for goes up, but you haven’t sold it, it is still more valuable. But you haven’t made any money on it. That extra value that the item has is called an unrealized capital gain (sometimes referred to as an unrealized gain). This gain is not taxed because it hasn’t resulted in any real additional income to you. Likewise, if you buy something and the value goes down but you still hang onto it, it is called an unrealized capital loss because you haven’t lost any money until you actually sell it.
Selling When The Value Goes Down
At times, someone may tell you that it a good idea to sell something after its value goes down. One reason for selling something if it goes down in value is because it might continue to go down in value. Beanie Babies were very popular at one time, and people paid more money for them then they cost new. However, in the years since the Beanie Baby craze, most of them have gone down in value and aren’t worth much now.
Another reason for selling something for a capital loss is because there are some IRS rules that can reduce the amount of tax paid on capital gains profits if you actually lost money on other items by selling them. Being the IRS, there are lots of additional rules on when and how this can be done. However, if you are holding onto something that has lost value, a conversation with a tax professional about those unrealized losses could help reduce your tax bill.
By understanding capital gains and losses, you can be more informed when your tax and investment professionals use these terms in conversations. Keeping them informed about things you have that you might want to sell – either for a profit or not – can sometimes even benefit you when it comes to tax time.
Disclaimer: This article is intended for educational purposes only and does not constitute tax or legal advice.
Want more of this?
This is one of three articles we sent to our subscribers this month. If you subscribe to our newsletter you’ll get additional content not found in our blog. Plus, the newsletter will be delivered to your inbox automatically. Subscribe Now