This article explains the circumstances in which the capital gains tax may apply to the sale of a business, and outlines a number of ways that you can reduce your capital gains tax on these sales.
What Is Capital Gains Tax?
Capital gains tax is the levy that is made when an investment is sold. It will be owed for the tax year that the investment was sold.
There is long term capital gains tax and short term capital gains tax. If the investor has owned the investment for at least one year then the investor will owe long term capital gains tax.
If the investor has owned the investment for less than one year then short term capital gains tax applies. Capital gains tax is only charged once an investment is sold.
Short term capital gains tax are charged at the person's normal income tax rate.
Understanding Capital Gains Tax
When a taxable asset is sold, for example stock shares, the profits are referred to as being "realized."
These will only incur taxes once they have been sold regardless of how much they are worth or how long they have been held.
Special Capital Gains Rates And Exemptions
Some assets fall into different categories to the norm and are treated differently. These are;
Collectable items include, art, antiques, jewelry stamp collections and special metals. These items are taxed at a rate of 28% regardless of the individual's income.
Owner Occupied Real Estate
When it come s to real estate capital gains a different standard applies.
$250,000 of a personal capital gain from a sale of their home is excluded from taxable income, this double for a married couple filing jointly.
( $500,000.) However this only applies when the individual has owned and lived in the home for 2 or more years.
However, different from other investments, capital losses from the sale of a personal property, a home is not deductible from gains.
An example to demonstrate this would be if an individual bought a home for $200,000, they later decide to sell the property and it sells for $500,000 making a $300,000 profit.
The 250,000 exemption must apply to this meaning the individual must report a capital gain of 50,000, this 50,000 is subject to the capital gains tax.
How Is The Sale Of A Business Taxed?
The IRS typically looks at the assets of the business when applying the capital gains tax rules to a business.
These assets include real estate, property leases and machinery. As previously mentioned, the capital gains tax you pay on these will depend on how long you have held these assets.
How To Avoid Capital Gains Tax On The Sale Of A Business
1. Sell To An Employee Of The Business. By Selling Your Business To One Of The Employees This May Lower The Capital Gains Tax
By setting up the employee stock ownership plan you will not have to search for potential buyers. The cash you receive can then be placed into an investment plan, this will defer capital gains tax.
2. Look Into An Installment Sale
An installment sale allows you to sell your business in phases rather than receiving the payment and selling the business all at once.
With this method you can come to an arrangement with a seller to accept payments for the business in a number of installments over an agreed period of time.
Although this strategy does not completely eliminate the capital gains tax it allows you to spread liability of the tax payments over a period of time.
Capital Gains Tax Strategies
There are legitimate ways for an investor to reduce or even completely avoid heir capital gains taxes for the year.
The most simple of the ways to do this is to hold assets for more than one year before selling them.
This is a useful strategy to reduce the capital gains income tax as you will pay long term capital gains tax which is significantly lower than short term capital gains tax.
1. Use Your Capital Losses
Capital losses will lower your capital gains tax for the year.Any loss not used in the current tax year can be used can be taken fo=rom the income which will reduce your capital gains tax.
2. Use Tax Advantage Retirement Plans
There are multiple reasons to participate in a retirement plan, for example a 401k. One of these would be that your investments will increase every year but will not be subjected to capital gains tax.
Retirement plans are also a great idea because individuals are not expected to pay any tax on these invested funds until they choose to withdraw from the plan.
Even then, when you do choose to withdraw the withdrawal is only taxed as normal income, regardless of the investment.
3. Track Your Holding Period
There are multiple reasons to participate in a retirement plan, for example a 401k. One of these would be that your investments will increase every year but will not be subjected to capital gains tax.
Retirement plans are also a great idea because individuals are not expected to pay any tax on these invested funds until they choose to withdraw from the plan.
Even then, when you do choose to withdraw the withdrawal is only taxed as normal income, regardless of the investment.
Although you may not be able to completely avoid your capital gains tax payments, we have outlined a number of ways you can significantly reduce your capital gains payments in this article.
Reducing your capital gains tax is a great way to save money which canteen be invested in stocks and bonds. This then strengthens the economy meaning businesses have the ability to grow and create more employment.
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