Definition of Asset Value Crystallization
Asset value crystallization is the process by which profit or loss from an asset is realized upon its sale. The crystallization of realized investments refers to recognizing the profit or loss when selling an investment. Realized profits are subject to capital gains tax, which can be offset by capital losses. The IRS restricts wash sales, which are crystallization strategies where investors sell their shares at a loss and then immediately repurchase them to eliminate the tax burden. Capital losses can be carried forward to offset up to $3,000 of regular annual income until the unused loss amount is exhausted.
How Asset Value Crystallization Works
When investments are held, changes in their value affect the investor’s net worth but not their tax obligation. An investor’s potential tax liability only begins when the asset is liquidated. At this point, profit or loss on the investment is realized. Investors must pay capital gains tax when they realize profits from selling a security. The capital gains tax liability depends on several factors, such as the holding period of the asset, the investor’s income tax bracket, and even the type of asset. Capital gains from selling an asset held for more than a year attract long-term capital gains tax. Depending on your income, you may pay something or even 20% as long-term capital gains tax. Capital gains from selling an asset held for less than a year attract short-term capital gains tax, which is typically taxed at ordinary income tax rates.
What Asset Value Crystallization Means for Individual Investors
Value crystallization helps determine the value of profit or loss incurred by an investor upon selling or liquidating an investment. This information is invaluable, especially for tax purposes. Some investors may attempt to offset their capital gains tax liability by selling securities at a loss to crystallize the capital loss and then repurchasing the security under the assumption that the investment will appreciate later. This strategy is known as wash sales and is restricted by the U.S. government. The IRS does not allow the deduction of capital losses from securities that produced capital gains from another transaction within 30 days before or after trading at a loss. There are limits on the amount of capital loss deduction you can claim, so investors may only offset $3,000 of their regular income annually ($1,500 if they are married filing separately). However, realized losses can be carried forward indefinitely until the unused loss amount is used to offset future capital gains to reduce tax liability.
Sources
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Darick Klonowski. “Strategic Entrepreneurial Finance: From Value Creation to Realization,” page 357. Taylor & Francis, 2015.
IRS. “Publication 550: Investment Income and Expenses.”
Source: https://www.thebalancemoney.com/what-is-crystallization-5198593
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