Investor Education, Capital Gains Tax

Blain Reinkensmeyer

Posted on Mon 9th Apr, 2007 09:13:11 PM

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We need some more stock market education here on the blog, what does everyone think?! I feel I have been spoiling this party with contests, giveaways, sandwiches, and “let’s get ready rumble!”. And thus, we are going to take a short step away from the party and gain some high quality insight into Capital Gains Tax and the difference between short and long term capital gains.

First thing is first, what the heck is the capital gains tax? Well, being the investopedia obsessive person I am, this is what they had to say:

“A type of tax levied on capital gains incurred by individuals and corporations. Capital gains are the profits that an investor realizes when he or she sells the capital asset for a price that is higher than the purchase price.

Capital gains taxes are only triggered when an asset is realized, not while it is held by an investor. An investor can own shares that appreciate every year, but the investor does not incur a capital gains tax on the shares until they are sold.”

In Simple Terms

If you buy 100 shares of Microsoft at $25 a share (hypothetical discount!), and 6 months later decide to sell your 100 shares at $26, you have realized a profit. You made $1 for each share you owned, so you made $100, good job! Like any paycheck, you have to pay taxes on this though, which is known as capital gains tax.

Instead of paying the capital gains tax immediately when you sell the shares for your $100 profit, you pay them at the end of the year (or early spring) when you file your taxes.

Simple right? Capital Gains Tax is just lingo for paying taxes on income earned through trading in the stock market (or like venue). So with that aside, the only other aspect to discuss to get the basics down is the difference between short term capital gains and long term capital gains.

The Difference Between Short and Long Term

What the heck is difference Blain, tell us!? VERY SIMPLE, the only difference between the two is this, if you hold those shares of Microsoft for OVER a year then sell, it is considering long term capital gains. If you hold those shares of Microsoft for anything LESS than a year and sell, it is considering short term capital gains.

The 2nd part to this is just as easy and simple to understand. Just like in the example, if we sell those Microsoft shares for that $100 profit after 6 months, those profits are considered short term capital gains. Short term capital gains tax wise are subject to whatever tax bracket you are in, so they fluctuate. So, if you made $50k that year, than you would be taxed in the same bracket for that $100 as you were on your $50,000. Now, if you sold the stock AFTER a year for that $100 profit, than the profits are considered long term capital gains. Long term capital gains are ONLY taxed at 10% (depending). This is just basics of this and they are certain situations were that “depending” statement has meaning. To read more on this side of the equation, the Motley Fool has a good article on the matter.

Side Thought: Have you ever heard of the market getting “wild” in the final weeks of the year, and volume (or the amount of shares traded) surging? That is simply because people are selling their positions that are at a loss to get a write off from them. If our 100 Microsoft shares were worth $24 a share, and we sell before the year end, than on our taxes that $100 loss ($1 x 100 shares) is a write-off.