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Understanding Capital Gains

Publisher: Kelly Burkart – Posted on 03/08/2013 US Bank Connect

Almost every small business can have capital gains (or losses). These transactions can impact your taxes, cash flow, and ability to get financing. The more you understand, the better position you will be in to manage capital gains to your company’s advantage.

What are capital gains?

Capital gains refer to income derived from selling investments or capital assets that belong to your business. The capital gain is the difference between what you paid for an item and what you sold it for (minus depreciation, amortization, and fees related to the sale). You are taxed on that difference.

What are capital assets?

Capital assets, subject to capital gains tax, are company assets not easily converted into cash. Examples include stocks, bonds, real estate such as land and buildings, equipment, and machinery. Capital assets are usually owned because they enable the company to make a profit. This covers a wide variety of assets, for example, equipment owned by a construction company, the property a convenience store is built on, and cameras gear owned by a portrait photographer.

Capital assets do not include inventory, business accounts receivable, and other specific items.

What’s the difference between short-term and long-term capital gains?

Capital gains are classified according to the period of time they are owned, which is known as the “holding period.” They are either short-term or long-term.

Short-term capital gains are income from assets held less than one year. This income is taxed at regular income tax rates.

Long-term capital gains are income from assets held 12 months or longer. This income is taxed at a “capital gains rate,” which is typically less than the regular income tax rate. Holding assets for longer than 12 months is usually advantageous because it enables you pay a lower tax rate, have more working capital on hand, and maintain better cash flow.

You can also reduce or defer capital gains tax by selling capital assets in installments across more than one tax year, rather than all at once.

What if you sell capital assets at a loss?

Selling assets for less than you paid is called a capital loss. If you have capital losses of up to $3,000, you can deduct the amount from ordinary income. In some cases, capital losses offset capital gains.

Are all businesses’ capital gains taxed the same?

The structure of your business determines your capital gains tax rate. For example, in a partnership, the income “flows through” to the owner’s individual tax return. On the other hand, corporations (including S-corps) are subject to corporate tax rates.

How do capital gains impact business other than at tax time?

Understanding and managing capital gains is important beyond their impact on your annual tax bill. If you plan to pursue financing for your business, you’ll want to make sure capital gains don’t have a negative impact on the value of your business. If you need to liquidate assets, you need to assess which will be the least detrimental in terms of losses and taxes.

Your tax advisor is the best person to guide you through the intricacies of capital gains, and you’ll want to rely on him/her or face the possibility of costly errors. Having a basic understanding of capital gains and their impact on taxes will help you become a better financial manager.

Kelly Burkart is a freelance writer from Minneapolis, Minn. While she has spent most of her time writing about financial services the past 15 years, she has also explored and written about everything from cardiovascular health to travel, higher education and sustainable energy practices.

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