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IV. Capital Gains The IRS Cut. When the value of an asset (investment) increases, it is called capital gain . When you sell the asset, the Internal Revenue Service (IRS) takes a share of the profit by imposing a capital gains tax . The capital gains tax is based on the difference between what you
Basis = Original cost of investment + taxes, shipping, fees and costs of improvement. Sale price – Basis = Capital Gain
paid for the asset (plus expenses such as tax, shipping, fees, commissions, and improvements) which is called basis , and what you sold it for. For example, let’s say you bought 100 shares of stock for $1500 + and paid a $100 commission to your broker. Ten years later, you sell the stock for $3400, paying another $100 commission. Your basis would be the original cost of the stock plus the two commissions: $1700. The difference between $1700 and sale price of $3400 is the profit which is taxed as capital gain. Watch Your Timing! When selling a capital asset (which is basically anything you invest in) timing is everything. The IRS treats long term and short term investments differently. If you sell an asset for a profit within one year of acquiring it, the IRS charges a steep and painful short term capital gains tax which is currently a whopping 39.9%. If you hang on to the asset for more than one year before selling it, the IRS charges a long term capital gains tax , which is substantially lower at about 15%. The IRS gives Americans a bit of a break on the sale of their personal residence. Most of the profit is exempt from capital gains tax as long as you’ve owned it for at least two years . When selling an investment, always consult an accountant or qualified investment advisor to minimize capital gains tax! Reflect on Learning: Can you name the different asset classes? Answer: Cash, real estate, equity, and debt. Can you briefly summarize the differences between asset classes and provide a description of each and how they can work over time to build wealth? When you begin investing, whom should you consult to avoid things like capital gains timing errors. Answer: A professional investment advisor and accountant. Recall that building wealth is like a second job. Learning about the many different types of investments and how to build a diversified portfolio is part of that job. There is plenty of excellent information online to help you learn about investing. PRODUCT PREVIEW
THE BIG PICTURE
Investing is the best means for pursuing long term financial goals. While investing is riskier than putting money in a savings account, it has the potential to bring a much higher rate of return. There are endless ways to invest: stocks, bonds, residential or commercial real estate, mutual funds, and collections. Risk and return are closely associated. Generally, the higher the potential return on an investment (ROI), the higher the risk. The lower the return, the lower the risk. Experts advise diversifying an investment portfolio to provide a balance that hedges against loss. When you become an investor, read all of the disclosures you are given. Investigate your investments! Learn as much as you can about wealth building and consult with investment professionals to increase your ability to achieve your long term financial goals.
Chapter 11 | Investing 101 206
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