For some of us, the world of finance is a confusing place. Taxes, pensions, investments, assets, liabilities...what does it all mean? For others, it’s a place they love. To each their own.
But even if you find everything related to finance downright perplexing, it is your duty to try for at least a general understanding. Ignorance of rules, regulations, and laws is no excuse should you ever find yourself in trouble.
Take capital gains, for example. You’ll often encounter the term in the news, especially as it relates to capital gain tax. But what is it? How do you compute your capital gains? Read on…
The Short Answer
Capital gains refer to profit from the sale of your capital assets. These may include investment property, stocks, or bonds. Start keeping meticulous records for any asset you acquire, as you may be required to pay tax on it down the road.
If what you sell it for is more than what you paid for it, you have a capital gain. Similarly, if you get less than what you paid for it, you’re looking at a capital loss. That’s the quick and easy explanation. In some countries, capital gains are part of your taxable income for the year. In others, it is excluded. It’s a good idea to check for your specific location at tax time, but if you’re looking for a quick answer, check out this list of Capital Gains Tax by Country. In many places, capital gains are taxed at a lower rate than regular income so as to encourage investment amongst its citizens.
So, is it really that simple? Yes and no. Finding your basic capital gain or loss is essentially a simple formula: Asset Selling Price - Asset Purchase Price = Capital Gain (positive) or Loss (negative). But you’ll likely be able to include various other expenses (broker fees, lawyer fees, improvement costs, etc.) to the equation. Each country does it a little differently in terms of exemptions and rates. Here are a few to get you started.
Capital Gains in the United Kingdom
Any time you dispose (aka sell) an asset, you should calculate your gain or loss. Keep track of it, and then it’s a relatively easy computation to find your capital gain or loss for the year at tax time. For tax purposes, you need to record:
- Description and purchase/acquisition date of the asset
- Sale Date and Amount - this is usually the amount you sold it for, but be aware that it could be the current market value in some cases
- Additional Costs - this could include broker fees or improvement costs
Using the basic formula, determine if you have a gain or loss. With property, for example, you may be able to deduct additional expenditures related to improvements you made while the owner, and this will lower the taxable amount.
Determining the sale amount is sometimes the current market value if you a) gave the asset away, or b) sold it for well under market value.
The U.K. has a capital gains allowance, or set amount, for each tax year. If your total gain is less than that amount, it is not taxed. Any amount over it is taxable income (roughly 18%, although there are exemptions and ways to lower it).
Capital Gains in the United States
Ten Important Facts About Capital Gains
You work out your basic gain or loss in the same manner. All capital gains must be reported in the US, and failure to do so could land you in serious trouble (don’t mess with the IRS). Also, be aware that America is one of the few countries to tax their citizens on all world income, regardless of where they live or where the income comes from.
The capital gains tax is, generally, lower than the income tax rate. For most individuals, you’re looking at 15%, although it could be as low as %5 or as high as 20% depending on your tax bracket (tied to your overall income). Additionally, it is possible to further reduce and/or defer the payment of the capital gains tax via various methods, but they are best left explained by an accountant or tax specialist.
The US classifies capital gains as either short-term (on assets held for less than one year) or long-term (more than one year), and the tax rate may change based on the classification. Be honest.
Capital Gains in Canada
Again, the basic formula will provide your overall capital gain or loss. Keep meticulous records all year (as you should for all finances), and finding it is very easy.
The capital gains tax in Canada applies to only 50% of the total amount. If you sold stock for $275, and you paid $200 for it, then you’re looking at a capital gain of $75. Only half of that, or $37.50, would be taxed at the basic rate for your tax bracket (dependent on total income). For example, if your tax rate is 40%, then you’d pay $37.50 (50% of the capital gain) x 40% = $15. You would pay $15 in capital gains tax for that transaction, giving you a total profit of $60 ($75-$15).
As with the US, it is possible to defer or reduce the amount of capital gains tax via various channels and exemptions. Talk to you accountant.
Capital Gains in Australia
The system is, in most ways, identical to that of Canada. Compute your capitals gains and losses by the basic formula. Capital gains tax is applicable for only 50% of any realized capital gains that year, at the individual income tax rate. The sale of several personal assets, including your residential home and car, are exempt from the capital gains tax in Australia.
If you have both capital gains and losses in the same calendar year, the losses can be used to offset the gains (gains - losses = total gains). If you have capital losses, but no capital gains, you can usually carry it forward to another year when you do have gains, which can be rather handy.
A Few Definitions
- Capital Asset - a fixed asset, such as property, stocks, bonds
- Capital Gain - profit from the sale of property or investment
- Capital Loss - the amount by which an asset purchase price exceeds the selling price
- Realized Capital Gain/Loss - the actual gain or loss once an asset is sold
- Unrealized Capital Gain/Loss - the potential loss or gain for an asset currently held
- Short-term - less than one year
- Long-term - more than one year
- The Basic Formula - Proceeds of Sale - (purchase/acquisition price + related outlays & expenses if applicable)
Finding your overall gains and losses is a straightforward procedure, but each country does have its subtle variations as to how you report it, and how to control it. Compute your capital gains and losses each time their is a capital event (you sell or get rid of a capital asset). You can get a general idea on how much (if any) you'll have to fork over in taxes, and you can set it aside for tax time. You'll want to do a little geographically specific research to maximize the deductions and exemptions in your individual case...that way, those gains you managed to make this year end up in your pocket.