What Are Capital Gains and Losses?

Capital gains are profits realized when an investor sells an asset for more than the purchase price. The asset could be a stock, bond, cryptocurrency, real estate, or any other investment. Say you bought one share of ACME for $100, held it for 6 months, and then sold it for $120. This would trigger a short-term capital gain of $20 to report to the IRS. However, if you waited for 12 months or more, you would incur a long-term capital gain instead.

Short Term vs. Long Term Capital Gains

Capital gains are viewed by the IRS in two different perspectives: short-term and long-term capital gains. Which type of capital gain you report on your tax return can significantly impact your tax bill.

The tax rate associated with capital gains is determined by how long the asset was held. If the asset is held for one year or less, the tax is the same as the individual's ordinary income tax rate, while assets held longer than a year are taxed at a lower rate.

There are a few reasons why capital gains are taxed at a lower rate. One reason is that the government wants to encourage investors to hold assets for a longer duration instead of trading them (or flipping them) as lots of short-term trading leads to a less stable market. The lower tax rate from long-term capital gains is likely not going anywhere since it is a key part of government tax policy. Investors should be aware of the tax implications when making investment decisions.

There are a few factors to consider when deciding whether to hold an investment for a shorter or longer duration. The first consideration is how much you expect to gain from the investment. Generally, short-term capital gains are taxed higher than long-term capital gains. In 2018, the tax rate for short-term capital gains was the same as your ordinary income tax rate, while the tax rate for long-term capital gains is 0%, 15%, or 20%, depending on your income level. Another factor to consider is how much risk you're willing to take on. Investments that have the potential for greater short-term gains also tend to come with greater risk, while investments with greater long-term potential often come with less risk.

Ultimately, whether you should hold an investment for a short or long time depends on your individual situation and preferences. If you're comfortable taking on more risk to potentially earn higher profits, you may want to consider investing in assets that have shorter holding periods. However, if you're looking for less volatility and lower potential taxes, you may want to invest in assets with longer holding periods.

What Is Net Capital Gain?

The IRS defines net capital gains as the total amount of long-term capital gains minus any short-term losses for the given year. This means if you sell an investment for more than you paid for it, you have a capital gain. However, you have a capital loss if you sell an asset for less than you paid for it. A net capital gain may result in a lower tax rate.

Tax Loss Harvesting

Tax-loss harvesting is a strategy to reduce taxable income involving selling securities at a loss to offset any capital gains realized during the same year. This technique can minimize taxes in any given year and be especially helpful when income is high, and tax rates are correspondingly high. Tax-loss harvesting can also be used to establish a loss for tax purposes that can be used in future years.

Conclusion

Capital gains or losses are considered a taxable event when you sell anything the IRS deems a capital asset. A capital gain occurs when the asset sells for more than your initial investment, and a capital loss occurs when the assets it sold for less than the initial investment. Whether you should hold onto an investment for a short or long duration for tax purposes depends on your personal situation, investment goals, and potential return. Tax-loss harvesting is a strategy that can potentially lower your taxes from investing.

It is recommended to consult with a financial advisor and tax professional to help you lower your taxes and maximize your returns from investments.