It was the final semester of my senior year in college and I was in the midst of trying to nail down a job when I received a surprise letter from the IRS (dun-dun-DUNNN!). Apparently, I owed Uncle Sam about $400. Aside from a bunch of numbers and language that might as well have been Mandarin, I couldn’t understand how or why.
From what I was able to gather from a few professors, the money was taxes owed on investments my mother had in my name that she liquidated to help pay my college tuition. Since the investments were in my name, the IRS was coming after lil’ ole me instead of my mom. I sent the IRS $100 at the behest of an adviser at school, in order to stave them off while I tried to figure things out. After months of brooding, online research, and calling the IRS, I finally spoke to an agent who broke down my situation in simple English.
I owed capital gains tax.
The young IRS agent told me that I was taxed on whatever net gain I made on my investment.
Whheeewww! Talk about breathing a sigh of relief.
“Capital gains tax is the tax on the gain of a sale of an asset,â€ says accountant Gil Michel, founder of the Indiana-based accounting firm The Caleb Group and personal finance Website BlackMoneyMatters.com. “It doesn’t just apply to stocks, it applies to any asset – such as income property, a boat, motorcycle, etc.â€ While Michel says capital gains tax is usually paid at the federal level, some states also assess it.
All I had to do was calculate the difference between the price at which my mother purchased the investments and the price at which she sold them. I had to pay tax on whatever the net gain was.
But here’s the kicker when it comes to stocks: When a stock is sold, what’s reported to the IRS is the total amount received, not the net gains, explained Michel. For instance, say you sold a few shares for $1,000 but you bought them at $600. The $1,000 is reported to the IRS as a gain (and, subsequently, that’s what you’ll be taxed on), not the $400 net gain.
It’s up to you to notify the IRS how much was paid for the investment and the actual gain by filling out a Schedule D: Capital Gains and Losses form.
In 2008, a number of capital gains cuts that former president George W. Bush pushed through in 2003 to spur investments took effect. According to Forbes.com, taxpayers whose income was low enough to keep them in the 10% or 15% ordinary income tax bracket would pay a 0% tax rate on the gains of a sale on an asset they’d held a year or more. That provision will be phased out by the end of this year.
It’s important to figure out the true cost of the investment, which may include more than just the purchase price. Every time you buy a stock or mutual fund, it’s important to keep good records.
“Where rental property is concerned, it’s not just what you paid for the house, it’s also what you paid in legal and survey fees,â€ says Michel. Basically, you need to take into account all the costs you paid in obtaining the asset, which may include the costs of a broker.
Got it? A little information can go a long way.
Renita Burns is a staff writer at BlackEnterprise.com.