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What Is the Capital Gains Tax?

How the Difference Between the Short and Long Term Rates Affects the Economy



There's a difference between short and long term capital gains taxes.

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What Is the Capital Gains Tax?

Gains on stocks trades are often taxed less than income.

Photo: Getty Images

You may be paying more in taxes than these hedge fund managers.

Photo: Laurence Mouton/Getty Images

Definition: Capital gains is the money you make when you sell something you own. A capital loss is if you sell it for less than you bought it for. Capital gains is calculated as the total sale price minus the original cost of the property.

Short-Term vs Long Term Capital Gains

Short-term capital gains or losses is when you've owned the property for a year or less. Long-term capital gains or losses occurs if you sell it after more than a year after buying it. 

Capital Gains Tax Rate

The IRS taxes all capital gains. In general, it taxes short-term capital gains at a higher rate than long-term capital gains.

The long-term rate was raised for higher-income taxpayers for the 2013 tax year to help pay for the Affordable Care Act. If you make more than $200,000 a year ($250,000 for married couples filing jointly, and $125,000 for married couples filing separately), ypu're taxed an extra 3.8% on the lesser of (a) investment income such as dividends and capital gains or (b) adjusted gross income that is above the threshold. This tax also applies to capital gains from selling a home, or other real estate for personal use, if your income was above the threshold, and your capital gains was greater than $250,000 (singles) or $500,000 (married couples). For more, see Obamacare Taxes.

Short-term capital gains tax rate - All short-term capital gains are taxed at your regular income tax rate. Therefore, it's usually better from a tax point of view to hold onto your investment for more than a year.

Long-term capital gains tax rate -  Your tax rate paid on most capital gains depends on what income tax bracket you fall in: 

  • If you are in the 10% and 15% income tax brackets, you pay no capital gains tax.
  • If you are in the 39.5% income bracket, you pay 20%.
  • Everyone else pays a 15% tax on capital gins.  

Long-term capital gains on collectibles, such as stamps, coins, and precious metals, are taxed at 28%. 

You can declare capital losses on financial assets, such as mutual fundsstocks, or bonds. Losses can be declared on hard assets, such as real estate, precious metals or collectibles, if they weren't for personal use. For more detail, see Short-term and Long-term Capital Gains from the About.com Expert on U.S. Taxes, William Perez.

If you have long-term gains in excess of your long-term losses, you have a net capital gain to the extent your net long-term capital gain is more than your net short-term capital loss, if any. If your capital losses exceed your capital gains, the excess can be deducted on your tax return and used to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 if you are married filing separately.If your total net capital loss is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you incurred it in that next year. (Source: IRS, 10 Important Facts About Capital Gains and Losses)  

How It Affects the Economy

Studies show that 70% of capital gains go to people in the top 1% of income. That's because most people have their assets in tax-deferred accounts like 401(k)s and IRAs. 

People who live 100% off of their investments, no matter how much income they derive, never have to pay more than 20% in taxes. This applies even to hedge funds managers and other on Wall Street who derive 100% of their income from their investments. In other words, they pay less than someone making $40,000 a year. Compare to other 2014 income tax rates here.

This does two things. First, it encourages investment in the stock market, real estate and other assets. That generates business growth. 

Second, it creates more income inequality. That's because those who derive income from their investments are generally already wealthy. They've had enough disposable income in their life to set aside for investments. In other words, they didn't have to use all their income to pay for food, shelter and healthcare. (Source: The Washington Post, Do Capital Gains Taxes Help or Hurt Our Economy?, September 12, 2011)

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