Understanding Capital Gains Tax for Small-Business Owners
When it comes to minimizing tax liability, small-business owners can use all the help they can get. One area where it pays to understand tax law is capital gains tax.
Selling capital assets—such as real estate or stocks—through your business results in a capital gain or loss. The difference between the purchase and sale price determines your gain or loss. When you have a capital gain, you owe capital gains tax.
According to Ken Moll, founder and principal of Integrated Executive Solutions (IES), “Effective capital gains management leads to a smaller tax bill, which means you have more working capital and better cash flow.”
Capital gains tax directly affects how small-business owners manage their assets. Mistakes in handling capital gains can result in costly tax penalties and legal or accounting fees, says Kevin Cloward, CPA and senior manager at Saddington Shusko.
What Are Capital Assets?
Capital assets include:
- Stocks and bonds
- Real estate
- Personal property held for investment
They exclude inventory, certain creative works, accounts receivable, and specific U.S. publications.
How Capital Gains Tax Works
Capital gains tax applies to assets sold for more than their “basis”—the acquisition cost minus any depreciation, amortization, or disposal fees. For example, if you sell a property for more than you paid (minus closing costs), the profit is taxed.
Tax treatment depends on the classification of the asset:
- Capital Property: Held for investment; qualifies for capital gains treatment.
- Dealer Property: Held for sale (inventory); does not qualify.
“Intent is everything,” says Cloward. Determining whether an asset is capital or dealer property is often contested in tax court, so be cautious.
Short-Term vs. Long-Term Gains
Tax rates vary based on how long you hold the asset:
Short-Term Capital Gains
- Assets held for one year or less
- Taxed at ordinary income rates (up to 35% in 2012, 39.6% in 2013 if Bush tax cuts expire)
Long-Term Capital Gains
- Assets held longer than one year
- Taxed at lower rates (15% in 2012, increasing to 20% in 2013)
- Additional 3.8% Medicare tax in 2013 for high earners (AGI over $200,000 for individuals, $250,000 for joint filers)
To reduce tax liability, hold appreciated assets for more than 12 months. However, with the new Medicare tax, consult your accountant about timing asset sales.
Ways to Defer or Reduce Capital Gains Tax
1. Installment Sales
For non-dealers, spreading payments over multiple years allows gain to be recognized gradually, reducing immediate tax impact.
2. Section 1031 Exchange
Also known as a “like-kind exchange,” this strategy allows you to defer capital gains by reinvesting proceeds into a similar type of property within 180 days.
- Applies to business or investment properties
- New property must equal or exceed the basis and debt of the old property
3. Offset Gains with Losses
- Capital losses can offset capital gains
- Up to $3,000 of losses can be deducted against ordinary income annually
- Unused losses can be carried forward indefinitely
Armed with this knowledge and guidance from your accountant, you can make smart tax decisions that improve your business’s financial health.
