You can typically reinvest capital gains with no restrictions imposed by the financial industry or the Internal Revenue Service. However, even if you reinvest your earnings, you can face tax liability for capital gains. The IRS allows you to make a certain amount of tax-free profit if you sell your primary residence, but you typically must pay capital-gains taxes on profits earned from investments such as stocks. Certain reporting and reinvesting strategies can help you reduce your tax liability before reinvesting your earnings.
You can earn a capital gain on numerous types of investments, including real estate, stocks, bonds or collectible items, such as art or coins. If you earn a profit when you sell an asset, the IRS typically considers your earnings as a capital gain. The IRS bases capital gains or losses on the basis of your asset.
Basis refers to the amount of money you have invested in an asset. For example, the basis of your home can include its purchase price, along with other purchase costs, such as sales tax and real estate fees. If you make improvements to your home that increase its value, such as installing central heating, you must record an increase the basis of the property. Increasing an asset's basis can often reduce your tax liability when you sell it.
Long-Term vs. Short-Term Gains
If you sell assets such as stocks or bonds, and earn a profit, you typically must pay capital gains taxes, even if you reinvest your earnings. The amount of capital gains taxes you must pay can depend on whether the sale constitutes a long-term or short-term capital gain. If you sell shares of stock owned for less than one year, the IRS considers earnings as a short-term gain. However, if you hold the shares for one year or more before selling, your profit will constitute a long-term gain. The IRS typically taxes short-term gains based on your regular tax rate, while long-terms gains are often taxed at a lower rate.
Offsetting Capital Gains
You can offset the tax consequences of long-term and short-term capital gains with capital losses. However, as of the 2010 tax year, the IRS only allows you to take an annual capital loss deduction of $3,000, or $1,500 if you are married and file separately. You must apply capital losses to the same types of capital gains. For instance, you can apply $1,000 in short-term capital losses against $1,000 in short-term capital gains. If you have long-term losses, you can apply those against long-term capital gains. By utilizing the capital loss deduction, you can reduce your tax liability before reinvesting your capital gains.
Real Estate Capital Gains
If you sell your primary home, you may be able to avoid paying capital gains taxes before reinvesting your earnings. As of the 2010 tax year, the IRS allows a maximum profit of $250,000 tax-free when selling your home, or up to $500,000 if you are married and file jointly. You can use your tax-free real estate earnings to reinvest in any type of financial vehicle, without restriction.
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