ETFs hold an edge because they tend to use passive investing and have some tax advantages.
What is a capital asset?
A capital asset is an item that you own for investment or personal purposes, such as stocks, bonds or stamp collections. When you sell a capital asset, you earn a capital gain or a capital loss, depending on the price. Gains are taxed at a special rate, and losses can be used in many cases to reduce the amount that is taxed.
A capital asset can be used in a business sense as an asset investment that is anticipated to generate some kind of value over a specified period of time.
Capital assets have these characteristics:
- The asset has an expected useful life of greater than one year.
- The acquisition cost of the asset exceeds some predetermined company minimum amount, also known as a capitalization limit.
- The asset is not anticipated to be sold as part of normal business operations.
- The asset is not easily convertible to cash.
For tax purposes, the classification of a capital asset differs. While the above classification holds true as a broad definition of a capital asset, what one company deems as such may not actually qualify under this classification for tax purposes.
Additionally, individuals and businesses can hold capital assets. For tax purposes, many types of property are considered capital assets, but the following holdings are excluded:
- Stock or other property that can be counted as inventory.
- Property used for a trade or business.
- A copyright that is held by and created by the taxpayer’s own efforts.
- Accounts receivable that are associated with the operation of a business.
- Any publication of the U.S. government.
- Any commodities derivative financial instrument.
- A hedging transaction that is clearly identified as such.
- Supplies consumed though the regular course of the taxpayer’s business or trade.
When you file your taxes, you must designate gains or losses incurred as the result of applicable capital assets as such.
Capital asset example
If you have stocks that pay yearly dividends, your stocks are capital assets. The yearly payout that you receive is considered a capital gain and is taxed accordingly. Conversely, any losses are considered capital losses and may have some tax benefit for you.
Want to know what your tax responsibilities are for your latest capital asset gains? Learn more about how to calculate tax for these gains.