Uncommon Cents

A capital gain is the amount by which the sale of a capital asset (such as an investment in stock or real estate) exceeds the purchase price. For tax purposes in the United States, a capital gain may be considered “short term”, meaning the asset was held one year or less, or “long term”, meaning the asset was held for longer than one year. Typically, short term capital gains are taxed at a higher rate than long term capital gains; in this country most short term capital gains are taxed as ordinary income, while long term capital gains have a maximum tax rate of 15% at this time. This is designed to encourage entrepeneurship and long term investment. If the asset is sold for less than the purchase price, this is termed a capital loss and may result in a tax break for the seller.

Mutual funds, particularly actively managed mutual funds, may accumulate capital gains that are eventually distributed to the fund owners. If the mutual fund is not held in a tax advantaged account such as an IRA or 401(k), the fund holder will be responsible for taxes on the capital gain distributions.

In practical terms, let’s say I bought a share of stock for $100 on January 3, 2007 and sold it on December 28, 2007 for $110. It would have been held for less than a year, therefore I would incur a short term capital gain of $10 and that $10 would be taxed as ordinary income in my case (25%). If, instead, I bought the stock for $100 on January 3, 2007 and sold it for $110 on January 4, 2008, it would be considered a long term capital gain, and the $10 gain would receive favorable tax treatment at a rate of 15%.

Understanding what capital gains are and the way they are taxed can help you make better decisions about buying and selling assets. Hopefully, this was of some help to you.

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