Capital Assets

• A capital asset is a term the Internal Revenue Code uses to categorize all personal and investment property you own, but not property you use in a business. Capital assets include virtually everything you own such as your home, the furniture in it, your car, stock investments and collectible items, to name just a few.
  
  

Calculating Tax Basis

• Every capital asset you own has a tax basis which represents the cost to acquire, construct and improve the asset. For example, when you purchase a home, the tax basis includes the full sales price and most of your closing costs such as legal fees, title searches and bank fees. However, the tax basis of your home is not set in stone. If you ever make improvements to it that either prolong its useful life or increase its market value, you can increase the tax basis for those improvement costs as well. This same fundamental principle applies to calculating the tax basis of all other assets. If you purchase stock, for example, its tax basis is the market price you pay for it plus any commissions your broker charges.
  
  

Taxable Gains and Losses

• Knowing the tax basis of your assets is important because it is the threshold amount that determines if you must recognize a capital gain or loss on a subsequent sale. For example, if you purchase a stock for $50 and your broker charges a $5 fee to execute the trade, your tax basis in the stock is $55. If you later sell the same share of stock for $100, you have a taxable capital gain of $55. But if you sell it for $30, you have a capital loss of $25. However, how you treat this gain or loss depends on the length of time you own it before the sale.
  
  

Asset Holding Periods

• The tax code classifies all capital gains and losses as short-term or long-term. If you sell a capital asset within one year of its purchase or construction, the resulting gains and losses are short term. Logically, all other transactions are long term. At the end of the year when you report all capital asset transactions on a Schedule D form, you must first net all short-term gains and losses together and then separately net the long-term transactions. You then combine the two results to arrive at your overall gain or loss. However, the overall gain that relates to your short-term assets is subject to ordinary income tax rates and your long-term gains are subject to lower capital gains rates.