“Capital gains tax” is one of those terms thrown around by cable news talking heads that you’re pretty sure is important, but have no clue what it means. It sounds like one of those terms that you don’t need to worry about unless you have hedge fund investments. But failing to understand capital gains tax can not only have serious implications for your business, it can also affect your personal taxes. And believe it or not, they’re a lot easier to figure out than you might have guessed.
What Is a Capital Gains Tax?
Simply put, capital gains tax is a tax on an asset you sell for more than what you paid. This asset can be almost anything: investments, property, jewelry, heavy equipment, collectible autographed Bruce Springsteen guitars. If you bought it for one price, and sold it for a higher one, you pay tax on the difference.
“But I’m in retail!” you say. “My whole business is based on selling stuff for more than I paid for it. Am I being taxed twice?”
Fret not, retail small business owner. Capital gains taxes only apply to assets, not inventory. So while any profits made off goods purchased and sold will still be taxed as business income, it is not taxed as capital gains.
However, if your restaurant bought a fancy pizza oven from Italy two years ago for $1,400 and sold it this year for $1,700, you’ll need to pay tax on the $300 difference. Or if your business purchased a piece of land for possible expansion then sold it at a profit before you expanded, that profit is taxed as capital gains.
The “base” – or the cost you calculate an item to have cost you when purchased– includes not only the purchase price, but also any tax, delivery, or setup charges, so talk to your accountant to try and maximize that figure.
How Much is Capital Gains Tax?
Capital gains tax is broken down into two categories: Short term and long term.
Short-term capital gains are assets you buy and sell within one year.
Long term capital gains are anything you buy and sell after holding for over one year.
The tax rate on short-term capital gains varies from 10-35%, depending on how much the capital gain is. Long-term capital gains are mostly taxed at 15%. The exception to this rule, interestingly enough, are collectables, which are taxed at 28%. So no matter how long you’ve had that Springsteen guitar, you’re paying a quarter of the profits over to Uncle Sam.
Long term capital gains are also only taxed for the year in which they are sold. So if it’s nearing the end of the tax year and you don’t think you can take the capital gains tax hit on a big item, it might be worth delaying the sale until the new year to apply the tax then.
Much like with business income, small business owners will also be taxed for capital gains on their individual income taxes. More double-taxation fun! The only way around this is to classify yourself as an S Corporation, which has a bevy of other tax implications but can at least keep you from paying double on your capital gains.
What If I Sell Assets at a Loss?
Gambling losses can be deducted on your taxes against gambling wins—and so can capital losses. So if that pizza oven ends up only setting for $1000 after you paid $1400, you can deduct that $400 loss against any capital gains. This is why many small businesses try and sell some assets at a loss to get their net capital gains down to zero.
As with most taxes, the rules for business capital gains and personal capital gains are different. And the guidelines we’ve laid out here won’t apply to your personal tax return, aside from the capital gains you’ve received in the course of running your small business. But as abstract a term as it might seem when you hear it on TV, capital gains taxes are for the most part pretty simple. Still, always confer with your accountant, explain your gains, and this part of your taxes will be a lot easier than you thought.