Cost basis can be a little confusing mainly because the way the tax code looks at it. In general, cost basis is the same thing as saying what you paid for something. If you buy a piece of property, your cost basis is the cost to accumulate that property, which may also include acquisition costs for the transaction. Knowing the cost basis is important because when you sell a capital asset you have to know what you paid for it and how long you owned it to determine the type and amount of gain or loss you will realize. A short term holding period is essentially if you own something for less than 12 months. Long Term holding period is if you own something for longer than 12 months. How does this effect your gains or losses? Price paid and time owned are the keys to determining your short/long term gain/loss. It’s also very important to understand there are many different tax considerations to know when looking at cost basis and gains/losses.
We’ve already determined what short term and long term are considered. Let’s look at the tax considerations for short term versus long term. For short term capital gains, you are taxed at your current tax bracket. If you’re in the 24% tax bracket or above, a short term gain will cost you more in taxes than a long term gain. Long term capital gains are taxed a 0%, 15%, or 20% depending on your level of income. If you’re single and make more than $445,850 or Married Filing jointly and make more than $501,600, then you pay the 20%. The majority of people fall in the 15% tax bracket for long term capital gains. It’s much more favorable for most people to have a long term capital gain than a short term capital gain. Before you decide to sell something of value like a home, investments, rental properties, businesses, etc. it’s very important to take into consideration your holding period and your cost basis. What ever you sell the asset for minus your cost basis is what you’re gain or loss would be for that transaction.
Losses are a little different than gains. Losses and Gains can actually be netted out to offset each other. If you’ve had a $10,000 long term gain and a $3,000 short-term loss, you net the difference to be $7,000 Long Term gain. Losses do have a limit that you can write off on your taxes. Typically, you can only deduct losses to match the capital gains and not to exceed a net loss of $3,000. If you have a loss of more than $3,000, then you have carry over losses. You can actually carry over that loss in future years for your tax purposes.
This is a brief overview of how cost basis and holding periods effect your tax liabilities. There are special rules for different types of investments not outlined in this overview. Please remember you should always consult your tax professional before you sell anything if you are concerned about the tax consequences of it.
IMPORTANT TIP FOR HOMEOWNERS: If you live in your home for at least two years, you don’t have to pay any capital gains on that property.
IMPORTANT NOTE FOR HOUSE FLIPPERS: If you like to buy and flip homes, you may make a good chunk of money, but you will also have to pay a good chunk in short term gains by not owning for at least a year.