Capital gains are often misunderstood by business owners. It’s not until a business owner is hit with a penalty from the Internal Revenue Service (IRS) when he or she realizes the importance of recording them. Whether you run a small or large business, you should familiarize yourself with capital gains and how they are used in accounting.
The Basics of Capital Gains
The term “capital gains” refers to the profits that are generated through the sale of an asset. If you sell an asset at a higher price than the amount for which you purchased it, you’ll incur capital gains. The difference between the asset’s original purchase price and its resell price is its capital gains. A real estate flipping business, for instance, may purchase a house for $75,000, after which it sells the house for $125,000. The capital gains on this real estate transaction would be $50,000.
Conversely, the term “capital losses” refers to the financial losses incurred through the sale of an asset. In a perfect world, every asset you sell would turn a profit. Unfortunately, this doesn’t always happen. You may even up selling an asset at a lower price than that for which you paid it. In instances where you incur financial losses such as this, it’s considered capital losses.
While capital taxes are taxable, you can minimize this financial burden by holding on to your assets for at least one year before selling them. When you hold an asset for at least a year, it’s considered a long-term capital gain — once the asset is sold — which is taxed by the IRS at a lower rate than short-term gains.
Capital Gains vs Dividends: What’s the Difference?
Although they share some similarities, capital gains aren’t the same as dividends. Dividends are simply assets that are distributed to a company’s shareholders. In accounting, dividends are recorded as income for the year in which they were distributed. Capital gains, on the other hand, are simply the profits generated through the sale of an asset.
How to Track Capital Gains in Quickbooks
Assuming you use Quickbooks, you might be wondering how to track your business’s capital gains. One way to track capital gains in Quickbooks is to create a separate account for them. You can create an income account, for instance, called “capital gains on [enter asset name]” Assuming you sell the respective asset for more than its original purchase price, you can then record the difference in the newly created income account.
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