Getting clear on capital gains, Part I

This is the first in a two-part series explaining capital gains.

There’s no doubt 2022 was a complete letdown for the average investor. Stocks, crypto, and real estate all took hits last year. The S&P 500 stock index was down nearly 20%, its worst year since the financial meltdown of 2008. Bitcoin, the standard by which all other cryptocurrencies are measured, lost more than 60% of its value. And red-hot real estate markets cooled across the nation as the Fed raised interest rates for the first time in over a decade.

Here’s the good news. This may be a great time to snap up discounts on investments that you might have deemed too expensive before. And over time, those great bargains can return a tidy profit! Of course, you’ll have to pay a capital gains tax on that profit. Let’s demystify this often-confusing topic so you can invest with peace of mind.

What are capital gains?

The IRS defines capital gains as any profit you make on a capital asset. Those capital assets are anything you use for personal purposes (like artwork, a car, or furniture) or that you hold as an investment (like crypto and stocks). There are two types of capital gains, realized and unrealized. We’ll look at realized gains first.

Let’s say you bought a stick of furniture for $50 and sold it years later for $100, you’ve then made a profit of $50. Those profits are realized gains because you actually get your hands on the money. But not all the money. Here’s why. The IRS lines up first for their share of the profit. How much, you ask? We’ll discuss that in next week’s post. But, for now, it’s enough to know the tax man cometh.

Unrealized gains are profits you made only on paper. For example, you have a stock you bought for $100 in 2022. At the end of 2023, it goes up to $150. But you don’t sell the stock. Instead, you hold on to it. So, the value of the stock has grown, but you don’t have any cash to tax. Yes, you are richer on paper, but the IRS won’t line up for their share until you have a realized gain.

What can and can’t be taxed as capital gains

Only capital assets can incur the capital gains tax. So, if you don’t hold it as an investment or for personal use, then the capital gains tax may not apply. But the IRS does consider stocks, bonds, your home, vehicles, furniture, collections, and even timber grown on your property as fair game for capital gains taxes. These lists are just examples. To fully comply with capital gains tax laws, it’s best to consult IRS Publication 544 or speak to a CPA.

Looking further into capital gains

So, anytime you sell something of personal use, there might be a chance of capital gains taxes coming into play. So, it’s best to consult a CPA if you have any questions about any investments or personal property you plan to sell in 2023.

Next week, we’ll look at how much you can expect to pay in capital gains and offer tips on how to lessen that load.