It doesn't matter what you're selling -- stocks, bonds, mutual funds, your home, rental property, your coin collection, your car -- anything. When you sell something, the Tax Man is looking over your shoulder. There are a number of things to know before you sell.

What is your cost basis?
Once you know the tax treatment for what you're selling, you'll need to 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 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 you've 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 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. The IRS website is a good place to start.

Don't forget that improvements add to the cost of an asset, business or personal. Likewise, sales commissions 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 know the rules, and make sure you can arrive at the correct basis for the asset 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 people 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's 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 its weight in gold.

Related Links:
Netting Out Capital Gains and Losses on Schedule D
Holding Period
Capital Assets... What Are They Really?
Home Sale Tax Exclusions
IRS Forms and Publications

If you like the way Roy Lewis simplifies confusing tax issues, check out his just-published book, The Motley Fool's Investment Tax Guide 2002: Smart Tax Strategies for Investors. This handy 360+ page guide covers just about every tax aspect of a typical Fool's life: investing, marriage, children, education, homes, home offices, retirement accounts, medical expenses, and much more.)

August 23, 2002

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