In an effort to separate investing for long term wealth creation versus short term speculation, the IRS taxes investment gains (known as capital gains) at a different tax rate. Whether it’s gains or losses, there are basically two categories that we are concerned about: long term and short term.
Long Term Versus Short
To determine whether the capital gains qualifies as short or long term, we should first determine it’s holding period (the time which the security is held). The calculation is based on the trade dates, not the settlement dates so if you bought a stock on February 6th, then you will have held onto the stock for one day on February 7th. Also note that the holding period is calculated based on the day of the month and not the number of days, so your holding period is one month on March 6th, two months of April 6th etc.
If you sold an asset that you held for a year or more, then it’s considered long term. Otherwise, it’s short term in IRS’ eyes.
Capital Gains are Taxed Based on Holding Period
So why is long and short term important? Because the IRS taxes them differently. As of writing, long term gains are taxed at 5% (for people in federal tax brackets in 10% and 15%) and 15% for the rest of the taxpayers. In contrast, short term gains are taxed as regular income tax rate.
Therefore, there is a big incentive for people to hold onto their investments. Let me give you an example. If you are in the 33% federal tax bracket, short term gains are taxed at 33% while long term gains are taxed at 15%, which is less than half!
Capital Gains and Adjusted Gross Income
Whether it’s long or short term, your net capital gains (or losses) are included in your adjusted gross income (AGI). This plays a big part in your taxes because that number is used to calculated your tax bracket, tax credits, as well as stimulus payments etc.
The only exception is that you can only deduct a maximum of $3,000 from your AGI in any given year even if you have more capital losses than that. The IRS however do let you carryover the losses for future years so if you had huge losses one year and never make any gains every again, you can theoretically take a $3,000 loss every year (until they change the laws of course). Note also that the carryover stops when you die, so there are no inheritance for carryover capital losses.
What Capital Gains Mean for Us
It is an important investment lesson to know that long and short term gains shouldn’t drive one’s investment decisions. While the tax rates difference is enormous, asset prices can change value much severe than that in a very short amount of time. Therefore, note that tax concerns should play only a small part of the overall investment decision.
Be mindful of capital gains but don’t let it be the only reason why you buy or sell.
In other words…
This is a form of tax applied to capital gains earned by either a corporation or an individual. These are gains which the investor realizes at the point at which they sell an asset for more than it was purchased for. These taxes aren’t charged while the investment is held, so at that point relative value is irrelevant, from the perspective of your tax burden. Upon sale, however, the asset is realized and the tax comes due.
In the U.S. parties are subject to these taxes on annual net capital gains. This is an important distinction since an investor might make a gain on one sale and a loss on another, and it is the net gain or loss which determines whether or not any tax is paid. Other countries apply different standards, so if you invest in foreign markets make sure you are aware of the local laws.
The result of a “chargeable event”, capital gains tax are paid when total gains for the year exceed the amount allowed for annual exemptions. An individual’s personal tax status can largely determine whether or not taxes are due in the end. Brokerages send out appropriate tax documents at the end of the financial year to help the parties determine their exact situation. Taken into account is the original cost, when the instrument was acquired, when it was sold and the proceeds attained
Any accountant should be able to evaluate your need to pay capital gains tax as do many tax preparatory software suites.
Promote or Save This Article
If you like this article, please consider bookmarking or helping us promote it!
Print It | Email This | Del.icio.us | Stumble it! | Reddit |
Related Posts
- Stocks Tax: The Basics
- Realized and Unrealized Gains and Losses
- 14 Facts About Form 1040 Schedule D for Investors
- What is Tax Deferred?
- What are Exchange Traded Funds (ETF)
Subscribe by Email
{ 0 comments… add one now }