11. Capital Gains Taxes
Capital gains taxes (CGT) are incurred when you sell the asset at a profit. CGT rates can vary by asset and by location so you'll need some tax advice to calculate correctly.
Taxes on capital gains
- Assets also incur taxes when you sell an asset at a profit
- These taxes are called capital gains tax (CGT)
- These taxes can vary by jurisdiction, by asset and by ownership duration
- As a result, always consult a tax advisor when calculating CGT taxes
How to calculate capital gains
Capital Gain = Selling price - [Adjusted Basis + Gain from depreciation recapture]
Adjusted basis is the net cost of an asset after adjusting for tax-related items.
- Calculate adjusted basis first before calculating capital gains
CTRL + Pg Down: Move to sheet on the right
CTRL + Pg Up: Move to sheet on the left
CTRL + →: Move to the last cell in the data region
SHIFT + →: Select next cell
The last part of our model that we need to calculate are the taxes associated with the sale of the asset.
In addition to the Capital gains tax, there's also a smaller tax on depreciation recapture, which may apply if the asset is sold at a gain.
Let's start by focusing on Capital gains tax.
To calculate the Capital gains taxes paid, we must first calculate the actual Capital gain.
In this example, based on the US tax jurisdiction, we start with the selling price, and we subtract the adjusted basis of the asset.
This will give us our gain on the disposal of the asset.
From this, we subtract the gain from Depreciation Recapture, which will eventually give us our Long-term Capital Gain.
At this stage, you're probably wondering what the adjusted basis means.
Well, the adjusted basis is simply the net cost of an asset after adjusting for various tax-related items, such as accumulated depreciation.
In truth, it's probably the hardest part of calculating Capital gains.
To calculate the adjusted basis, I start with the Purchase Price, add Purchase costs, Improvements, Legal fees, and Selling costs before subtracting Accumulated depreciation.
I could also include some losses, such as theft and casualty, but I'll ignore these for this example.
Adding these values together, I'll get my adjusted basis.
In our model, we will only have three adjustments: Purchase costs, Selling costs, and Accumulated depreciation.
Let's now move into Excel to calculate the Adjusted basis.
In our model, I've added five new assumptions to our dashboard: Purchase price, Purchase costs, Selling costs and the two tax rates, and of course, I've named these cells.
Now let's go to our financial model and calculate the adjusted basis.
So I'll start with the PURCHASE PRICE which is $1,400,000, and I'll add the PURCHASE COSTS, which will equal to the purchase price multiplied by the PURCHASE COSTS, which is simply a percentage.
Next I'll add the selling costs which will simply be the SALE PRICE multiplied by the SELLING COSTS, which again are a percentage.
And finally I'll subtract depreciation, and this will be the SUM of all of the depreciation on the asset, and I can find that here, and I'll simply select these cells.
I'll now add these values together to calculate my adjusted basis.
With this value in place, we can now calculate our Capital gains tax.
So I'll start with the SALE PRICE, and then subtract my Adjusted basis, and this will give me my Gain on Disposal.
I must now subtract the gain from Depreciation Recapture which will simply be the depreciation I calculated earlier, and this will give me my long-term capital gain.
To calculate the TAX ON DEPRECIATION RECAPTURE, I'll take the amount and multiply it by the relevant tax rate, and to calculate the tax on Capital gain, I'll take the amount and multiply it by the CAPITAL GAINS TAX.
Now if I add these two values together, I get my total tax liability on the sale of the asset, which turns out to be just under $127,000.
As I've mentioned previously, these tax rates can vary quite a bit.
For example, if you hold an asset for a short time period, say less than a year, you may end up paying a higher rate of tax.
In addition, different states within the US and different countries have different tax rates for Capital gains.
You should always consult a tax advisor when calculating your tax liability to make sure your calculations are correct, as they can have a big impact on your final cash flows.
In the next lesson, we'll wrap up our model by finally calculating our IRR.