One of the questions that I hear every tax season is related to Capital Gains Tax. Invariably someone will approach me with a question that goes something like this one.
“Hey, I sold some stock that I bought with my money I got for my high school graduation and wow, I made lots of money. I had a great time spending that money. Now I got a Form 1099-B from the broker who handled the sale for me. The broker said something about capital gains tax when we talked but I really didn’t pay much attention to him. Do I have to do anything with this 1099-B and what the bleep is capital gains tax anyway?”
So my response usually goes something like this.
“Wow, it’s great that you were lucky enough to make such a good investment with your high school graduation money and that you made lots of money. I do hope you didn’t spend it all though because you know the profit that you made on that sale of your investment above what you paid for the investment is in fact taxable income. It is called a capital gain and is subject to capital gains tax. You probably should have paid closer attention to what your broker was telling you as you would have then realized that you should put some of the proceeds of the sale away to cover the tax due on the profit. But it is commendable that you opened your 1099-B when you received it in the mail and had the presence of mind to keep it as you will have to use it for tax preparation time.”
As an answer to the question, what the bleep is capital gains tax, I generally try to explain that capital gains tax is a tax on the sale of a capital asset. A capital asset is almost everything you own and use for personal or investment purposes such as your home, household furnishings, stocks and bonds.
When you sell a capital asset you must report the sale on your personal income tax return on Form 1040 Schedule D. The difference between what you paid for it, or the basis, and what you sell it for is a capital gain or loss. If you sell it for less than you paid for it you actually have a capital loss to report on your tax return which decreases your taxable income and therefore decreases the tax liability that you owe. The amount of loss that you can take each year may be subject to some limitations; and losses from the sale of personal-use property such as your home or your car are not deductible. If you sell a capital asset for more than you paid for it, you have a capital gain and have to pay tax on the gain.
You may be required to make estimated tax payments at the time of the transaction to avoid an underpayment of tax penalty so you should consult a tax professional or contact the IRS for information and advice. You can also refer to IRS Publication 505 Tax Withholding and Estimated Tax.
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