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For an individual interested in finance and investing, it is essential to understand the concept of capital gains. A capital gain is a profit received by buying and selling a capital asset, such as stock in a company, real estate, bonds, fine art, or other assets. The taxes on capital gains vary, depending on what kind of capital asset an individual invests in, and how long the asset is held. Short term capital gains are profits obtained by selling an asset that was held for less than one year. In the United States, short term capital gains are taxed at the same rate as ordinary income, such as wages from employment, or interest.
Most often, the short term capital gains tax rate is much higher than the long term capital gains tax rate. For example, the majority of people are in the 15% tax bracket for long term capital gains taxes, but in the 33% tax bracket for short term capital gains tax. The reason for this large difference is to minimize short term investments that tend to be risky and speculative in nature, with the theory that this would give more stability to the economy and less volatility to markets where assets are traded.
The Internal Revenue Service (IRS) allows taxpayers to defer short term capital gains taxes through the use of tax planning strategies, such as charitable trusts and 1031 exchanges. There are many such methods, each with its unique benefits and drawbacks. As always, the advice of a tax accountant on these matters is helpful for those who wish to properly take advantage of these techniques.
When calculating short term capital gains, it is important to note that the amount that is taxed is what is called the "net capital gains". This means that if an investor has two stocks, and sells one for a profit and another for a loss, then the amount of loss from the losing investment will count against the capital gains realized from the sale of the profitable investment. This has the effect of lowering an individual’s tax liability, compared to what it would be if their losing investments were ignored by the tax laws.
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