Recognized Vs. Realized Gains
When you sell an asset, you may face federal income tax liability if you earn a profit. The Internal Revenue Service makes a distinction between a realized vs recognized gain. While a recognized gain may create a tax liability, the realized gain often determines the amount of tax you must pay. The IRS taxes capital gains earned from the majority of assets, but profits from certain assets may include tax exclusions.
Capital Gains and Income
When selling an asset for a profit, you must report your earnings to the IRS as income. The IRS requires capital gains earnings for the majority of assets, which can include real estate, bonds, stocks, jewelry or art. If you sell an asset for a profit after owning it for one year or more, the IRS considers your earnings a long-term gain. If you sell an asset for a profit after owning it for less than one year, your earnings are considered a short-term gain. You typically face a lower tax liability for long-term gains compared to short-term gains.
Basis and Capital Gain
Determining the amount of a capital gain begins with its basis. In the majority of cases, the basis of an asset means the money you initially spent in the acquisition. For example, if you buy a new home the basis of the property can include the purchase price, along with costs such as sales tax, real estate agent fees and recording fees. In certain cases, you must adjust the basis of an asset. For instance, if you expand your property by acquiring a lot next to your home, you can increase the basis of the property. To calculate a capital gain from the sale of an asset, you must first deduct the cost basis from the sale price.
Recognized Gain Basics
The IRS considers a recognized gain a profit earned from the sale of an asset. A recognized gain only considers the difference between the basis of the asset and the sale price. For example, if you own a share of stock with a basis of $25 and sell it for $35, you earn a recognized gain of $10. When selling securities, such as stocks or bonds, you often must pay capital gains taxes, depending on your overall income. However, if you sell your primary home for a profit, you may not face taxes on your recognized gain. As of the 2020 tax year, the IRS allows you to make a tax-free profit of $250,000 on a primary residence, or $500,000 if you are married and file jointly.
Understanding Realized Gain
According to Investopedia, realized gains refer to the amount of money you actually earned in the sale of an asset. The difference between realized and recognized gain is clear because when calculating your realized gain, you must deduct any costs associated with the sale. For example, if you sell shares of stock, you can deduct brokerage fees when determining your actual earnings. The final earnings after all cost deductions equal your realized gain. The IRS allows you to deduct certain costs associated with the sale of an asset and typically taxes your earnings based on realized gains.
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Writer Bio
Michael Evans graduated from The University of Memphis, where he studied photography and film production. His writings have appeared in numerous print and online publications, including International Living, USA Today, The Guardian, Fox Business, Yahoo Finance and Bankrate.