Capital Gains Tax – Detailed Guide and Simple Explanation

This is the basic basic guide you could hope to find on capital gains taxes. Capital gains taxes are incredibly important to understand on your way to extending your portfolio, improving returns, and minimizing your tax expenditure beyond income tax. Capital gains tax are often confused for dividends tax, but this common misconception is one of the many basic steps in this simple explanation guide. First, we go through what capital gains even are, and then continue on to how capital gains are taxed. Capital gains taxes also form one half of the two types of dividends taxes!

Capital Gains Explained – Investment Basics

Capital gains sounds like the best and most confusing financial term you could come up with. It has connotations of wall street and Gordon Gekko, villas in the Hamptons, and invetment portfolios worth millions. Let us take you on the journey of capital gains (and capital losses), and what you need to know about them. You may come in contact with capital gains taxes as part of the dividends you receive, from mutual funds, or from other forms of finances or investment strategies and portfolios.

Capital Gains Definition: What is Capital Gains Income?

By definition, a capital gain is when capital becomes more valuable. This capital is capital asset, and most typically in the form of stocks. Usually the capital gains or losses occur when selling an asset (such as stock in a company). A capital asset, i.e. the thing gaining in value, is also often called a security. Capital assets can occur in the form of stocks, funds, real estate investments, or any number of investment portfolios

• A capital asset which has increased in value since purchase

What are Examples of Capital Gains? How Capital Gains work

Let’s take the example of a real estate investment. You buy an apartment in New York for $300.000. It was in a particularly up-and-coming neighborhood, and now five years later it’s worth $400.000. At this point it is an unrealized capital gain of $100.000. If you decide to sell this apartment, and you get your asking price of $400.000, you will have made $100.000. This is your realized capital gain.

$400.000 – $300.000 = +$100.000 Capital

Now let’s say you decided to invest in a neighborhood which did not fare so well over the years. Suddenly your apartment did not increase in value to $400.000, but rather decreased in value to $250.000. Then you will have unrealized capital loss. If you decide to sell this apartment (perhaps to avoid further depreciation in value), you will have a realized capital loss of $50.000.

$250.000 – $300.000 = -$50.000 Capital

What Counts as Capital? Capital Asset Definition – Dividends, Stocks, Co

To understand what a capital gain really is, it is important to understand what things count as capital themselves, what is the thing gaining in value when we speak of capital gain. Looking at regulations, capital assets are defined as a piece of property which has significant value. That means a quilt given to you by your grandma for free, which you sell for $15, is not a capital gain. Still, capital assets are more far reaching than most people often think: it’s not just related to stocks, but it’s also relevant to dividends, mutual funds, and more. These are all types of capital assets:

• Property, e.g. real estate
• Jewelry, Collectibles, or Art
• Stocks
• Bonds
• Investment Properties

What is the Difference Between Realized Capital Gains and Unrealized Capital Gains? Paper Gains, Paper Losses

Capital gain is, as defined above, just an increase in the value of an asset. This increase in value can occur any time of course, and usually happens a tiny bit every day. A capital gain can therefore occur anytime, but if the asset’s owner were to never sell, then this increase in value would be irrelevant. This type of increase in value, where the owner does not sell, but if he were to sell, he would sell it for a higher price than he bought it, is called unrealized capital gain or paper gain. The increase in the assets value is not transferred to real in-pocket-money, and rather only occurs on paper. A realized capital gain is when the owner ‘cashes out’ and sells his assets for more money than purchased.

• Realized gain is when asset increases in value and is sold
• Unrealized gain (or paper gain) is when the asset is not sold, but would incur capital gain if sold

What Types of Capital Gains are There? Short-Term, Long-Term

Typically you differentiate between short-term and long-term capital gain or loss. As mentioned above, when you own capital it typically changes in value. If you hang on to this capital for less than a year before realizing your gain (i.e. before selling), it is a ‘short-term capital gain’. If, on the other hand, you have owned this capital for longer than a year when you sell it, it qualifies as a ‘long-term capital gain’. These distinctions are quite important because they decide how the profit you make from your investment is taxed.

• Short-term capital gain is when you sell after owning the capital for less than a year
• Long-term capital gain is when you sell after owning the capital for more than a year

How is the Value of Capital Calculated? Details, Explanation, Example

Some capital assets are more straightforward to calculate than other. For example, buying 10 stocks at 30$ a share is quite simple to calculate because the total value of the capital is at 10 x $30 = $300. Other capital assets are much more complex. Take for a example a property, where the land is worth $30.000, and the land owner also builds a dock with a boat. Now the total construction of the dock cost $50.000, and the boat cost $20.000, but the transport of the materials for the dock cost $8.000 and for the boat an extra $2.000. That means the current value of the items is at

$50.000 + $20.000 = $70.000

Yet, when looking at the value of capital such as this, all costs are factored in, which means that for example transportation costs would also be included, leading to a total capital value of

$70.000 + ($8.000 + $2.000) = $80.000

This example demonstrates that the value of capital is desided by all costs (including e.g. insurance costs) in the acquisiton of the asset. In the eyes of the IRS, these are also called capital expenses. By the way, if this scenario took place in Florida, there would be the addition of the documentary stamp tax (Florida’s version of the real estate transfer tax), one of the real estate purchase taxes, and the owner would have to pay the state of Florida property taxes.

What is a Capital Gain Tax? Rates, Long- and Short-Term, More

So we’ve gotten to the heart of what capital gains and losses are, how they are categorized and how to calculate them. Only thing left now is to understand how to tax them. This is probably easier than you imagine, but harder than it should be

Capital Gains Tax Definition: What is Capital Gains Tax?

Capital gains tax is a tax on the profit you make with investment in capital assets. If you buy stocks and sell them for more money than you bought them, you have made profit (i.e. capital gains), and this extra money that you are receiving is taxed. If you sell capital for more than you bought it, you will necessarily, by law, pay capital gains tax.

• Tax on investments which gained value, e.g. stocks that grew

Capital Gains Tax Example Calculation – How Capital Gains Tax Works, Formula

So, let’s say you are filing your taxes. For the past two years you have held some stock in a great company, but now are looking to buy a new car. You sell your stocks for $10.000 more than you bought them for. That means you have realized capital gains of $10.000. Because you held these for longer than a year, you will be taxed at the capital gains tax rate. Also, because you are not married and do not have a partner, you are filing single. For a single filing, below $40.000, there is a 0% tax rate. Great! So on this capital gain you will pay no taxes!

$10.000 x 0 = $0

Now, what if you held on to the same stocks for another year, and then decide to sell them. In this time they gained so much in value that you realize a capital gain of $60.000! Now you will be in a higher tax bracket, that means that you will have to pay some taxes. For capital gains tax rates (see the full details below), the second bracket starts at $40.000 in capital gains. That means you will have to pay 15% tax on the $20.000 which exceed $40.000

($40.000 x 0) + ($20.000 x .15) = $3.000

That means you will have to pay $3.000 in capital gains taxes from your $60.000 realized capital gain.

Are Short-Term Capital Gains Taxed Separately from Income? How Capital Gains Taxes Work

Although, it is important to distinguish taxes on capital gains and capital gains taxes. The capital gains tax only applies to long-term capital assets (i.e. owned for longer than a year), while short-term capital assets are taxed as if they were normal income, at the income tax rate like the salary you receive from work. Capital gains tax rates are lower than income tax rates!

• Short-term capital gains are taxed using income tax rate
• Long-term capital gains are taxed less with capital gains tax rate

When do you Have to Pay Capital Gains Tax?

This is a good question. If you hang on to good stock for 20 years you will continually be becoming more and more wealthy, yet are not paying taxes… right? Yes! You pay taxes on capital gain when this gain is realized. This is what’s called a ‘taxable event’. That means when the event (i.e. selling your capital) occurs, you pay taxes. If you never sell your capital, you won’t have to pay taxes on it! Your tax bill is never affected by unrealized capital gains or losses.

Do you have to Pay Tax on Capital Losses?

No! You do not have to pay taxes on capital losses, because you are not making any money. Quite the opposite, you can deduct capital losses from your tax bill. This is one of the most important ways to reduce your taxes. More on that below.

• You do not have to pay tax on capital losses
• You can deduct capital losses from your tax bill

Capital Gains Tax Rates – USA

The USA has a federal capital gains tax, but also many states have their own capital gains tax rates. That means you have multiple stops that your capital gains will be taxed at.

USA – Federal Capital Gains Tax Rates List, Brackets

For the federal level, your capital gains are taxed at the following rates if you are filing single

• 0% tax: <$40.000
• 15% tax: $40.001 – $441.450
• 20% tax: >$441.450

How much is Capital Gains Tax in New York? Rates, Brackets, List

The state of New York has no free-standing capital gains tax rate. Here, long-term and short-term capital gains are equally taxed using the state’s income tax rate. Just like New York property tax rates, the income tax rates are relatively high, but see for yourself. In New York capital gains are taxed at these rates:

• 4% tax: $0–$8.500
• 4,5% tax: $8.501–$11.700
• 5,25% tax: $11.701–$13.900
• 5,9% tax: $13.901–$21.400
• 6,33% tax: $21.401–$80.650
• 6,57% tax: $80.651–215.400
• 6,85% tax: $215.401–$1.077.550
• 8,82% tax: $1.077.551 +

How much is Capital Gains Tax in California? Rates, Brackets, List

Just like the state of New York, California also has no free-standing capital gains tax rate. Here, long-term and short-term capital gains are equally taxed using the state’s income tax rate. California income tax rates are also quite high, thanks its mega metropolises Los Angeles and San Francisco housing some of the biggest companies in the world. In California capital gains are taxed at these rates:

• 1% tax: $0-$8.809
• 2% tax: $8.809.00-$20.883.00
• 4% tax: $20.883-$32.960
• 6% tax: $32.960.00-$45.753
• 8% tax: $45.753-$57.824
• 9,30% tax: $57.824-$295.373
• 10,30% tax: $295.373-$354.445
• 11,30% tax: $354.445-$590.742
• 12,30% tax: $590.742-$1.000.000
• 13,30% tax: $1.000.000 +

How to Avoid Capital Gains Tax – Saving Money with Deductions

If you are receiving dividends, you probably want to pay as little as possible in taxes. Giving away money that you have invested and worked for seems harsh. Better to structure your taxes better and save money. Maybe not save money from your dividends taxes, but just give less away.

Best Trick for Real Estate: How do I Avoid Capital Gains Tax on Property?

You pay no federal taxes on qualified dividends when your total income is below $39.375! That means if your income is higher, suddenly you have to pay more taxes, and will end up with less money in your pocket in the end. In this case you could actually save money by just working less so as to avoid reaching the point where you have to pay the dividends or capital gains taxes. Remember: This only applies to the federal capital gains taxes.

• No capital gains tax when income is below $39.375

Looking for more ways to save on your tax bill, check out our top tips!

Real Estate Tax Deductions

Tax Deductions for Companies! Capital Expense Deductions

Important in the topic of capital gains, are the fact that acquiring capital assets is incentivized by the state. That means that if you are clever enough to form an LLC or an S corp, you can write off big purchases such as machinery, property, or other items which can count as capital assets. Remember though! Most expenses have to be written off over time, if you buy a car for your business, you cannot deduct the full price of your tax bill in one go.

• Capital expenses can be deducted from tax bill

How to Save Taxes with Capital Losses – What to do when Capital Loses Value

If your investment has lost value, it may hurt at first. This is normal though, and isn’t as bad as you first thought perhaps. This is because you can deduct capital losses from your tax bill. That means you pay less taxes because your investment did not turn out well! Only one catch, while you have to pay taxes on capital gains for all types of assets (e.g. even jewelry), you can only deduct capital losses when you bought your asset for investment purposes. For example stocks, property, etc. are all purely investment, and therefore can be deducted when losing in value.

• Deduct capital loss from tax bill
• Only possible for assets purchased for investment

How to Offset Capital Losses – Capital Gains Tax Explanation, Example

If you have made a significant capital gain in a year, but also capital losses (which, let’s be honest is quite common and to be expected), then you can write off the capital losses. For example, if you have made $200.000 in capital gains over some particularly lucrative stock, but have also made $100.000 in losses from a particularly poisonous investment, then you only need to pay taxes on the $100.000 of profit you made on the first. This is why it is called offsetting, because you offset some of the gain you make with the losses.

• Reduce your capital gain by the amount you lost through your capital losses

Tax Special! Income Tax

To learn about dividends tax means to learn about income tax as we’ve learned. That’s not a problem though because we have a simple guide for learning about income tax for the very beginners. It is a simple explanation of everything you need to know about paying income tax, how to tax income and everything in between. Income tax is something that will follow you forever, so it’s best to get to know it now and forever hold peace with it.

USA Income Tax

Tax Special! Dividends Tax

Dividends tax also utilize capital gains taxes! Although dividends also carry their whole own addition of complications and confusions. We’ve writtena nother helpful and simple guide to learn everything you need to know about dividends taxes, how they work, when they occur, and of course also how to save money on your dividends taxes. No doubt you’re going to learn something very important in this article.

Dividends taxes are taxes on the dividends which you receive as a shareholder in a company. What are dividends? In a sense they are like the company sharing part of their income with you, as a reward and incentive of being a shareholder in their company.

USA Dividends Tax

Tax Special! Property Tax

As mentioned, taxes on property are nearly as complicated as on income or capital. Property taxes, where they are taxed, what they tax, and how to pay less property taxes, can all be found in our all-encompassing guide on property taxes.

Property tax is often confused as being a tax on real estate property. Yet this is a misconception. The largest proportion of property taxes come from real estate, because this is the most expensive property most people own. Yet property taxes can also be levied on airplanes, computers, furniture, etc. In the U.S., each person pays an average of $1.617 in property taxes a year. The state which pays the most property taxes is New Hampshire with $3.307.

USA Property Taxes

• Part 1: Classical or exotic investment – Which real estate is suitable as capital investment?
• Part 2: Real estate as a capital investment – What do I have to pay attention to?

Investments: The Most Popular Investments

Question: You have gained a lot of experience with different capital investments! Please give us a pro and contra for each of the most popular capital investments in terms of value and success.

Then let’s start with this: What are the most popular capital investments at the moment? I can think of stocks, government bonds, all of this is also funds, then also precious metals and even commodities. As a real estate expert, I naturally think of the so-called “concrete gold”, houses and apartments.

Let’s start with shares as a capital investment. The big chances for big capital yields certainly speak for it. Especially if you are not urgently dependent on the invested money in your everyday life and possibly have a little more time to “give away” your money. And there also already the CONTRA lights up: Who invests its money in shares, must have either very much knowledge and time, in order to react to the occasionally strong price fluctuations with shares. The higher the chances of winning with share prices are, the more largely is also the risk to lose its money. Under no circumstances should you invest your entire capital in shares, and certainly not just in one “title”, i.e. shares of just one company! A distribution over several companies or better investment forms is in every respect the safest way to avoid defaults.

Want to invest? Tip: Buy shares cheaper via direct bank.

Funds do not Provide Any Investment Security

We get right into funds: Here, the large advantage is that the investor sets with the purchase of so-called fund portions immediately on a larger range of enterprise bonds. Simplified this means: if a share in the “pot” (i.e. the fund) is doing badly, the other share values can compensate. Advantage with the fund: a fund manager takes care of the stability and the best possible composition of the securities. Disadvantages: The fund manager wants to be paid. Therefore the capital yields with funds are usually not as high as with the direct investment. Also with funds there is no certainty that the investment income and the value of my fund shares will always develop only upwards. If several shares in a fund are quoted poorly because the companies issuing the shares are not doing well, the value of a fund will also show a downward trend.

Question: But there are these so-called “annuity bonds”. They are very safe!

That is true in principle, but for a long time now, the returns on investment with this form of investment have been very poor. Why? Well because bonds or also called government bonds are nothing more than a kind of savings book. You lend money to a state and the state gives interest. Since the interest rate level is very low, however, a state also gives little or even no interest on the money it lends. By the way, there are also funds that mix the bonds of different states. Here it is important to look closely at which securities are mixed there. Who wants to have a healthy mixture of risk and security, should deal with so-called mixed funds. There stocks and “bonds” are mixed in different proportions.

Disadvantage here – as everywhere in the securities business: fees for the purchase of the shares and a usually very long “investment horizon”. So the period of time in which I should not have to dispose of my money. Otherwise the return on investment often becomes quite “meagre”. And another thing: I often only get the increase in value of shares and their funds if I sell the securities again and then feel a hopefully registered increase in value in my cash box. If I am lucky, the company pays so-called dividends on my shares. But you have to have a lot of shares in the company to get rich.

And finally: always remember that you have to pay taxes on the investment income!

Gold or “Concrete-Gold” – Where is my Money Safe?
Briefly, I will now turn to investments in precious metals and commodities:

Precious metals, especially gold, are rightly considered a safe investment. But: the increase in value is only very high in times of crisis. Otherwise one enters at present on a high price level and has only a small, however safe, value development. Raw materials (e.g. lithium) are a very complicated story. Much more applies here than to shares: this is something exclusively for experts with a broad market overview and expertise. The risk of losing your money is particularly high here.

Question: Is there such a thing as a “really safe investment”? What is the situation in terms of security, for example when comparing shares and real estate?

Basically, the rule is: the higher the security of the investment, the lower the chance of making “the big money”. Security reduces the chance of making a profit. In fact, real estate as a capital investment is already a very safe thing, if you consider some basic things. These include, for example, whether the property in which you want to invest your capital is located in a region with a large increase in value. In addition the purchase price must fit and the condition of the real estate should be in such a way that one does not have to put still “without end” money into the modernization.

As with the share, one should also assume that one should have a long investment period in mind for the achievement of capital yields. But after all, profits that you make when selling a property after ten years are tax-free! With a property – if I rent it out – I get my rental income. I have to pay tax on that too, but I can reduce the tax burden if I count expenses for modernization etc. against it. Roughly speaking, this means: the state supports me in maintaining and increasing the value of my capital investment.

Measure the value of a property correctly

Question: Certainly one needs some basic knowledge, in order to gain profits with investment – all the same which -. How do you appraise a property?

There are several possibilities. I’ll make it short and simple here: The value of the property plays a role (mostly in € per square meter). Then there is the size of the house, how old it is and in what condition the house is. The age of the technical installations (heating, water and electricity pipes) also plays a role. Very important: the location! It makes a big difference whether the house is located near popular cities or far away from them. In relation to the Rhine-Main area, for example, this means that a house in the middle of the Hunsrück is significantly cheaper than one near Mainz or Wiesbaden, while being the same size and with the same features.

If you want to buy a condominium as a capital investment, pretty much the same applies. It is somewhat different with real estate that the capital investor does not live in himself. In the case of a rented apartment or even an apartment building, the so-called capitalized earnings value is added as a basis for valuation. This to calculate is in any case thing of real estate experts.

Profitable real estate investment

Question: What makes a profitable real estate investment? Which factors should one pay attention to?

No matter whether you want to live in the property itself or rent it out: Whoever invests in a property should make sure that it has an optimal location for its purpose. This usually includes the proximity to stores for daily needs and to public facilities such as schools, etc.

Secondly, the location should be such that it will be in constant or even increasing demand over many years. Even if in – let’s say – 25 years time there will still be a move into the region of my property, this will ensure a decent increase in value and easy sale.

After all, the purchase price and the condition of the property must match. So I deliberately do not say that a property always has to be particularly cheap or expensive to get something for your money. For example, I can compensate for disadvantages in the location or condition of the property with a lower purchase price. A particularly expensive real estate however must already have a quantity of advantages, so that I get a lucrative investment in it.

This also applies to real estate that is not used by myself – and this is what you usually mean when you talk about real estate as a capital investment. Here one should look above all on the so-called “renting loss risk” The investor should let itself be shown, how frequently tenants in the house/the dwelling change and whether there are apprenticeships. Because only a rented object is suitable as capital investment.

Crisis Times and Gold

Question: In times of crisis gold is always recommended as a safe investment. What are your experiences? How do you evaluate the risk and the chances of making profits with gold investments?

I have already hinted at this above: I think very little to nothing of gold as an investment. There are very meaningful statistics that show that the value development of gold is significantly weaker compared to real estate for the same investment period. But perhaps the biggest difference is that I only make the profit from an investment in gold when I sell the gold again. Otherwise the gold is in the vault and does not yield any money during this time. The “concrete gold” on the other hand, i.e. a (rental) property, brings me money even if I don’t sell it. Month after month I get rent. That is, if you like, the interest rate for my invested capital. If I have chosen the right property, then I get a tidy profit on top – often even tax-free.

Question: Many Germans now like to invest in funds. How does such a fund work? How does a real estate fund work?

A fund is to be understood like a pot, in which many shares in companies or also real estate are gathered together. These shares remain in this pot as long as they have a positive performance or a correspondingly secure prospect of it. If at any time there is a “rotten egg” among these shares, it is removed and replaced by a new, better one. This is done by a fund manager who checks every day how the individual values in the fund are performing.

Now there are open and closed systems – both for shares and for real estate funds. The difference is that in a “closed fund” the number of issued share certificates or the amount of capital raised is limited. When the desired number is reached, the fund is closed. This becomes problematic when the companies or properties whose values make up the fund get into economic difficulties. So when the companies no longer make a profit or the properties no longer have any rental income. Since no more new capital can be added to the fund, the originally stored money – i.e. the investors’ capital – is used to pay the costs of the companies/properties. In the worst case the money is then simply lost.

Profits from Capital Investments: Levies and Returns

Question: What happens to the profit that my investment brings? What tax and legal issues do I have to consider? How is the return calculated and what remains of my profit?

Again a simple answer: Profits from capital investments must be taxed in Germany. How and in what amount a tax consultant knows best. Basically, there are allowances, i.e. parts of the profit from capital investments which I do not have to tax. But if you invest larger amounts and get noticeable profits from it, you can’t avoid taxation.

In the case of real estate that I buy in order to rent out, there is at least the possibility to offset the achieved rental income against investments in the property. This has the advantage that I maintain the value of the property, maybe even increase it. The actual profit is generated when I sell the property again after a period of at least ten years and the property has experienced an increase in value. The difference between the purchase and sales price flows tax-free into my pocket. In the case of a self-inhabited real estate independent of the period between purchase and sale, in the case of a rented real estate after ten years.

Finally, the yield is the return that my capital brings in a certain period. All income and costs I have to pay for my capital investment are used for the calculation. A very simple calculation for real estate is the gross rental return. Here is the formula:

100 x annual net cold rent / purchase price of the property = gross rental return in %

Net rental returns and returns on equity are also common measures for determining the value of a property as an investment. I always recommend to have your real estate agent calculate the corresponding values and thus compare different properties in their quality as capital investment. That is very exciting!

Yes or No? Real estate as Capital Investment

Question: Once I have decided on a property as a capital investment – and this is becoming increasingly popular in Germany – where should I look for a suitable property? The big cities in the Rhine-Main area have already become very expensive due to the great demand, haven’t they?

That is unfortunately – from the buyers’ point of view – true. Of course there are always bargains in the direct conurbation. But for this you either have to have the “right nose” yourself, or a real estate agent who is very closely networked in the market.

But there are enough good and very good alternatives in the Rhine-Main area. Thus real estates are for instance in Bingen at the Rhine or environment in the relationship clearly more favorably. Since meanwhile also distances of 40 kilometers and more from the large center – thus Frankfurt, Mainz, Wiesbaden – are added to the conurbation, real estates here are really good capital investments. Whoever is interested in a house or apartment somewhat away from the centers should always make sure, however, that the transport connections are good and that there is a good infrastructure of schools, stores etc. in the town itself. In the long run, people will continue to live there and want to buy real estate. That again means rising prices and thus a good increase in value of the real estate as a capital investment.