Sole proprietorships are businesses owned by one person. Instead of reporting the income, gains and losses on a separate return, a sole proprietor includes his business’s annual fiscal activity on his personal tax return. A sole proprietor should include any capital gains the business might earn on his personal return. If you are a sole proprietor, you should consider consulting a certified public accountant or attorney when filing your returns.
Capital gains occur anytime you sell a capital asset for a profit. A capital asset is property held for investment purposes or to generate income. Goods that you sell or lease as part of your business are not capital assets. So if you sell cars, any cars you hold are not capital assets. Property that is used in your business, but depreciates, also isn't considered a capital asset; those types of assets are taxed using a different method. Examples of business capital assets are stocks, bonds and real estate held only for investment purposes.
Read More: Divorce and Responsibility for Capital Gains
As a sole proprietor, when you acquire an asset, you usually pay for it using cash that was taxed. As a result, the portion of the proceeds from the sale that equals how much you originally paid for the asset should not be taxed. Basis generally equals how much you originally paid for the asset. This value includes the taxes and incidental expenditures you paid to get the property. If you made additional investments in the property after the initial acquisition, such as rehabilitating a building you purchased, that increases your basis. If you claim any depreciation or if there was theft or damage to the property that was reimbursed by insurance, your basis in the asset decreases by that amount.
Capital Gain Taxation
To determine how the capital gain is taxed, you begin by dividing all the capital transactions you had for the year into two groups: short-term and long-term. Short-term transactions relate to assets held for a year or less; long-term transactions are for assets owned for over a year. Then you figure out the gain or loss for each transaction. Simply subtract the basis from the proceeds of the sale: if the result is positive, you have a gain; if negative, it’s a loss. Then you add all the short-term losses with the short-term gains and all the long-term losses with the long-term gains. Then you subtract any short-term capital loss from your net long-term capital gain. If you still have a gain after this, that amount is taxed at a rate no higher than 15 percent, depending on your total income for the year.
Tax Forms for Capital Gains
Since capital gains are included on the owner’s individual tax return, you would need to record the capital transactions on Form 8949 and Schedule D. Form 8949 allows you to record the specifics of each individual transaction, including when you acquired the asset, when you sold it, how much the asset cost and for how much you sold it. You then add up the results of the transaction on Form 8949 and transfer the results to Schedule D, which you use to determine your tax on the transactions and where to record the data on your 1040.
- Entrepreneur: Sole Proprietorship
- Internal Revenue Service: Ordinary or Capital Gain or Loss
- Internal Revenue Service: Publication 551 – Basis of Assets
- Internal Revenue Service: Tax Topic 409 – Capital Gains and Losses
- Internal Revenue Service: Schedule D – Capital Gains and Losses
- Internal Revenue Service: Form 8949 – Sales and Other Dispositions of Capital Assets
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.