What to Know Before Selling

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By Roy Lewis
September 21, 2001

It' really doesn't matter what you're selling -- stocks, bonds, mutual funds, your home, rental property, your coin collection, your car, anything. Any time you sell something, the Tax Man is looking over your shoulder. There are a number of things that you need to know, and we'll take a few minutes to discuss them here.

What is your cost basis?
Once you understand what it is you're selling and the corresponding tax treatment, the next thing that you'll need to do is understand the cost basis of that asset for tax purposes. For personal property, the cost basis is whatever you paid for the property. 

However, when it comes to business assets, you'll be claiming a depreciating that asset. And that depreciation will decrease the original cost of the asset to something less than what you paid for it. For example, let's say you purchased an office desk for $500. Over the last number of years, you've been depreciating that office desk, and using those depreciation expenses to reduce your yearly taxes. Say that you have taken $400 of depreciation against that desk at the time you decide to sell it. The adjusted basis on the desk, then, is $100 -- the original $500 that you paid less the $400 in depreciation. So if you sell that desk for anything other than $100, you'll have a tax consequence. Depreciation is a complicated topic, so if you're a business owner, it'll pay to learn more about it. A good place to start is the IRS website.

And don't forget that improvements add to the cost of an asset, business or personal. Likewise, sales commissions that you pay to buy a stock will be added to the cost of the stock for tax purposes. Make sure that you've made all of the appropriate additions and subtractions to the original cost of the property in order to arrive at your adjusted cost basis. It's tricky, so make sure that you know the rules and can arrive at the correct basis for asset that you're selling.

What are the tax consequences?
Once you've determined your cost basis, it's time to determine the tax consequences of the sale. Different assets have different tax rules; not all sales are created equal. Let's look at some of the rules. Remember: With all things tax, there are complications and exceptions that can arise in any situation. We'll give you the highlights here, but it's not the last word.

Personal use property: property that you use exclusively for personal purposes other than a personal residence or collectibles.

If gain: Taxed as capital gain, either long or short term depending upon your holding period. If long term, you would receive the benefit of a maximum 20% capital gain rate. If short term, your tax rate would be your normal marginal tax rate.

If loss: Non-deductible. There is no deduction for losses on personal use property.

Personal residence: your primary home.

If gain: Not taxable up to $250,000 for single folks and $500,000 for married folks if certain rules are met. If the gain is taxable because the exclusion rules are not met, the gain will be treated as a capital gain, either long or short term depending upon your holding period. If long term, you would receive the benefit of a maximum 20% capital gain rate. If short term, your tax rate would be your normal marginal tax rate.

If loss: Non-deductible. Again, there is no deduction for losses on personal use property.

Collectibles: such as stamp, gun, coin, and baseball card collections, or other valuables with collection value.

If gain: Taxed as capital gain, either long or short term depending upon your holding period. But these assets don't receive the benefit of the maximum 20% tax on long-term capital gains. Instead, the maximum long-term capital gain tax on collectibles is 28%.

If loss: Non-deductible. Once again, there is no deduction for losses on personal use property.

Investment property: property such as stocks, bonds, mutual funds, a second home (or other real property for which depreciation is not claimed).

If gain: Taxed as capital gain, either long or short term depending upon your holding period. If long term, you would receive the benefit of a maximum 20% capital gain rate. If short term, your tax rate would be your normal marginal tax rate.

If loss: Taxes as a capital loss, either long or short term depending upon your holding period. These losses can be used to offset other capital gains. But if you have more losses than gains, your deduction is generally limited to $3,000. The balance of those losses are carried over to the following tax year.

Business/investment real property: real property that you depreciate and is used for rental or business purposes, like your office building or that home that you rent out to others.

If gain: The gain must be segregated into two parts. The first part would be the gain realized from the recapture of depreciation expense previously claimed. That gain would be taxed at a maximum capital gain rate of 25%. If there is any additional economic gain, it would be taxed as a capital gain, either long or short term depending upon your holding period. If long term, you would receive the benefit of a maximum 20% capital gain rate. If short term, your tax rate would be your normal marginal tax rate.

If loss: The entire loss is generally deductible in the year of sale. There are no loss limitations as there are with non-depreciable real property.

Business personal property: personal property that you use (and depreciate) for business purposes, such as your office furniture, business computer, business auto, and business machinery/equipment.

If gain: The gain must be segregated into two parts. The first part would be the gain realized from the recapture of depreciation expense previously claimed. Unlike business real property, there is no special maximum capital gains tax rate applicable to the gain or recapture of depreciable personal property. Any such gain would be taxed at your normal marginal tax rate. If there is any additional economic gain, it would be taxed as a capital gain, either long or short term depending upon your holding period. If long term, you would receive the benefit of a maximum 20% capital gain rate. If short term, your tax rate would be your normal marginal tax rate.

If loss: The entire loss is generally deductible in the year of sale. There are no loss limitations.

Gain or loss... minimize your taxes!
Regardless of whether you'll have a gain or a loss, there might be a way to accomplish the sale and still minimize your taxes. If you have business use property, you might be able to trade that property for similar property (commonly called a tax-deferred exchange) and avoid current taxes completely. And if you sell some of your stock for a loss, you might use that loss to offset some of the gains on other stock sales.

But again, it all boils down to knowing the rules for the thing that you're selling. Start with the articles in the "Related Links" box in the upper right-hand corner of this article. If you don't have the time to learn about the rules before you sell, then the advice of a qualified tax pro could be worth it's weight in gold.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

This forum and the information provided here should not be relied on as a substitute for independent research to original sources of authority. The Motley Fool does not render legal, accounting, tax, or other professional advice. If legal, tax, or other expert assistance is required, the services of a competent professional should be sought. In other words, if you get audited, don't blame us.