Preparing Income Taxes - Why You Need to Know About Capital Assets

The IRS is in the business of collecting revenue to support our government. It collects taxes on various forms of money we "accumulate". We are taxed on income we earn; on interest we receive on savings, on dividends from stock we own, and from gains or losses from the sale of our possessions. The IRS Tax Code often categorizes these possessions using negative definitions. It is very confusing! According to the IRS, "our stuff" might belong to some category of property UNLESS it is listed as an exception to that category! For example, in IRS-speak, capital assets are defined as any property that is not explicitly listed as an exception! Sounds crazy (or deviously clever)? Let's start with that negative definition...

Some stuff is real and some stuff is personal. Real stuff is typically associated with "dirt"; like real estate, buildings, or just land. Personal stuff is anything that is not real! Personal property is "movable". Your car, your refrigerator, and your lawn mower are stuff you can hold, move, or break. This "stuff" or property is tangible; it has "substance" and usually some intrinsic value. You can also have intangible property like pieces of paper called stocks and bonds. The value of the "paper" is in the rights of ownership it conveys; they are examples of intangible personal property.

Thus, almost all the "stuff" you own for personal or investment use is a capital asset. Your car, your refrigerator, your lawn mower are examples of personal-use property. The definition begins to blur though because while your home is real, personal use property, a rental home that is not your residence would be business-use property. That rental is maintained to produce some form of income. It might also be considered investment-use property because it has the potential to increase in value over time.

But there is an even more important classification the IRS relies on to collect revenue: holding period. When "stuff" is owed for periods of time that exceed 12 months and a day, the gain or loss from the sale of that property is classified as long-term rather than short-term. The net capital gain is the difference between more preferably long-term gains (or losses) over short-term gains (or losses). The tangible "stuff" you use for non-business or personal reasons is called a capital asset. When you sell this kind of "stuff", any profit or amount over the "original cost" is considered a capital gain and, most important, is taxable. You are required by law to report a capital gain on your income tax return. Depending upon the size of a capital gain, you might also need to make an estimated tax payment! You calculate the gains or losses on Form 1040, Schedule D, Capital Gains and Losses and transfer the net amount to Line 13 in the income section on the top page of your IRS Form 1040. You can find out more information on the IRS website, IRS.gov.