Things that you own for your own personal use, investment or pleasure are considered capital assets. Common examples of capital assets are your home, your car or stocks and bonds. Generally, a capital asset can be purchased or sold, either at a gain, or profit, or potentially at a loss. A certificate of deposit generally does not fit this description, as a CD is basically cash held in a bank account. In some cases, however, a CD may be treated as a capital asset for tax purposes.
A CD is, by its name, a deposit account. This means that you place funds on deposit with a bank, which in return pays you interest on the money you deposit. The biggest difference with a CD compared to any other type of deposit account is that you agree to leave the money on deposit with the financial institution for a specified period of time, and pay a penalty if you withdraw before that time, in exchange for a higher interest rate.
Pays Interest and not Capital Gains
The money that you earn from a CD is considered interest, and is reported as interest on your federal income tax forms. Interest income is taxed at your normal tax rates for income, just like your salary or business profit and loss. Capital gains from the sale of a capital asset are generally taxed at a lower rate, depending on your total income and how long you have held the investment.
Not Sold but Withdrawn
When you want the money that you hold in a CD, you go to the bank and make a withdrawal. You do not have to sell the CD back to the bank. If the withdrawal is before the maturity date of the CD, you will have to pay a penalty for this early withdrawal, but the money is still available to you immediately. Generally, a capital asset must be sold to liquidate the value of the asset.
Secondary Market CDs
In some cases, CDs may be sold on the secondary market. This means that you may transfer ownership, or the right to withdraw the funds from your CD to a purchaser in exchange for money. Usually, this is done because the CD is at a higher rate than what the purchaser can receive today. Or, you may sell the CD at a loss because rates are now higher than when you opened the account. A CD sold on the secondary market may be treated as a capital asset concerning the taxable gain or loss.
Craig Woodman began writing professionally in 2007. Woodman's articles have been published in "Professional Distributor" magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.