There are two types of capital gains, short-term and long-term. What is the difference between the two? It is quite simple. A short-term gain involves a gain from the sale of asset that you have not held for more than a year. Let’s say you buy stock in ABC company on February 1. Then on August 1 of that same year, you decide to sell it because you want the stock because it has gone up in price. You have held the stock for six months. Thus, you have short-term capital gain. If on the other hand, you wait and sell your stock after February 1 of the following year, you will have long-term gains.
Why is it important to have a long-term gain and not a short-term gain? The reason is for tax purposes. Short-term capital gains are taxed as ordinary income. This means you will pay taxes at the ordinary income tax rates in effect for the year, ranging from 10% to 35%.
The long-term capital gains is taxed at a special long-term capital gains rate. The rate that applies depends on which ordinary income tax bracket you fall under.
- Zero percent rate if your total income (including capital gain income) places you in the ten or fifteen percent tax brackets.
- 15% rate if your total income (including capital gain income) places you in the twenty-five percent tax bracket or higher.
Therefore, it is better to hold onto your investments for more than a year.