Capital Gains Tax

A capital gains tax is incurred when a capital asset is sold for a profit. Conversely, a capital asset sold for a loss represents a capital loss. The term "capital asset" is defined in the Internal Revenue Code as business or nonbusiness property held by a taxpayer, other than eight specific categories of assets that are excluded from treatment as capital assets. The most notable exceptions are business inventory, depreciable business personal property and business real property, and copyrights, literary, musical, or artistic compositions created by the taxpayer.http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001221----000-.html 

Examples of capital assets are a personal residence and any nonbusiness real property, stocks and bonds, automobiles, boats, jewelry, and nonbusiness personal property. These are common assets are regularly bought and sold.http://financial-dictionary.thefreedictionary.com/capital+asset 

The capital gains tax is imposed on capital gains incurred during a taxable year. Thus, gain from the sale of a capital asset is not reported on the income tax return as income. It is reported in a different section of the return. While the policy may be debatable, the tax rates for capital gains are lower than the tax rates for ordinary income. Capital losses can be used to offset capital gains, but they are not deductible from ordinary income.http://www.irs.gov/taxtopics/tc409.html 

When a person sells a capital asset for a profit, the capital gain is equal to the amount realized reduced by the adjusted basis for the asset. The amount realized is generally equal to the price paid by the purchaser of the property. The adjusted basis is what the seller paid for the property, subect to certain adjustments. One adjustment is that the cost of any capital improvements to the property is added to the adjusted basis. Also, for property received upon the death of a decedent, the cost basis is "adjusted up" to the value of the property on the date of death.http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00001221----000-.html

The manager of a successful private equity fund or hedge fund is entitled to a share of the partnership's profits as a form of inducement to maximize the fund's performance. The carried interest, typically 20% of the profits generated, is in addition to a relatively small management fee (typically 2%) and the manager's investment in the fund. Although the management fund is taxed as ordinary income, the carried interest typically forms the primary source of the manager's compensation.http://bostonvcblog.typepad.com/vc/2005/05/venture_capital.html 

If a fund invests for the long term, like many private equity firms, its profits are typically long-term capital gains and qualify for the reduced capital gains rate. The manager's carried interest has traditionally been taxed at capital gains rates because it is an interest in the partnership's profits. The treatment of a manager's carried interest as capital gains has been questioned because the interest is intended as compensation, which is taxed at the higher ordinary income rates.http://bostonvcblog.typepad.com/vc/2005/05/venture_capital.html 

The U.S. House of Representatives has passed H.R. 4213, which would require that a manager's carried interest be taxes as ordinary income rather than capital gains. The bill now passes to the U.S. Senate for consideration.http://www.opencongress.org/bill/111-h4213/show 

The change may be more a matter of raising revenues than implementing tax policy. The taxation of carried interest as ordinary income would raise more than $17 billion over the next ten years.http://www.nytimes.com/2010/05/29/business/29carried.html Proponents of H.R. 4213, however, contend that carried interest represents a fee for the manager's services and should be taxed as any other form of compensation for services rendered.http://victorfleischer.com/archives/80 Moreover, advocates see venture capital funds as benefiting unfairly from the reduced rates compared to other business segments.http://www.avc.com/a_vc/2010/05/why-taxing-carried-interest-as-ordinary-income-is-good-policy.html

Opponents of the proposed legislation argue that Congress should consider this issue as part of broader tax reform rather than on a piecemeal basis.http://www.bloomberg.com/apps/news?pid=newsarchive&sid=alm0Crt0eICY Opponents warn that the proposed taxation of carried interest removes any incentive for long-term, high-risk investment in new companies. http://www.nvca.org/index.php?option=com_content&view=article&id=229&Itemid=500 Moreover, decreasing venture capital would also discourage innovation and job creation. Robert L. Johnson, founder of Black Entertainment Television, has pointed out that an unintended consequence of the new legislation would be to deprive black entrepreneurs of funding because they often look to venture capital funds for start-up capital.http://www.nytimes.com/2010/05/29/business/29carried.html The National Venture Capital Association (NVCA), a lobbyist for venture investors, has been very active in attempting to convince Congress to retain the capital gains treatment for carried interest.http://www.nvca.org/index.php?option=com_content&view=article&id=229&Itemid=500

Up to $250,000 of gain from the sale of a primary residence can be excluded from taxation. In the case of a married couple, the exclusion is $500,000. A residence qualifies as a primary residence so long as the taxpayer lived in the home for at least 24 months during the five years prior to the sale. A primary residence can be a house, houseboat, mobile home, cooperative apartment, or condominium.http://www.irs.gov/publications/p523/ar02.html#en_US_publink1000200611

In general, the exclusion for sale of a primary residence does not apply to land only. Thus, if you own a mobile home and the land on which the home is located, a sale of the land only is not eligible for the exclusion. The sale of vacant land is not generally eligible for the exclusion.http://www.irs.gov/publications/p523/ar02.html#en_US_publink1000200611 

• Place of employment
• Location of main home of family members
• Mailing address for bills and correspondence
• Address listed on: federal and state tax returns, driver's license, car registration, and voter registration card
• Location of banks you use
• Location of religious organizations and recreational clubs in which you are a memberhttp://www.irs.gov/publications/p523/ar02.html#en_US_publink1000200611 

Under special circumstances, you may be able to exclude part of the gain on the sale of a primary residence even if you did not live in the house for 24 months:

• Job Changes. You can exclude part of the gain on the sale of a residence lived in for less than two years if your work location changes. The exclusion applies if you begin a new job and if you are transferred to a new location by your current employer.
• Health Conditions. You can exclude part of the gain on the sale of a house, even if the 24-month residency requirement is not satisfied if the house is sold for medical or health reasons.
• Unforeseen Circumstances. A partial exclusion may be available if the sale of a residence was due to unforeseen circumstances. An unforeseen circumstance is an event that could not reasonably been anticipated before buying and occupying the home. Examples include: natural disasters; acts of war; acts or terrorism; change in employment or unemployment; death, divorce or separation, and multiple births from the same pregnancy.http://www.irs.gov/publications/p523/ar02.html#en_US_publink1000200611 

If the special circumstances exist, you can calculate the partial exclusion based on the time you actually lived in the home as your primary residence.http://www.irs.gov/publications/p523/ar02.html#en_US_publink1000200611

Disclaimer: The content in this page is not a substitute for professional financial advice. Please contact a finance professional before using the information presented here.