To Sell, or Not to Sell......That is the QuestionMar 9, 2001 (Updated Apr 12, 2009) Write an essay on this topic.
The Bottom Line Long- term gains provide tax advantages to short term gains, but they should not be the sole determining factor, when you make a decision to sell.
When each year comes to a close, investors are often faced with making decisions about investments, and whether or not to sell them, or hold them until a later date. One of the important factors in making this decision, is the length of time the asset has been held, because the length of time will determine the status of the gain and, hence, the rate of taxation.
What is a Long- Term Gain or loss?:
Long- term gains/losses are defined as the income or loss that is realized on any asset that was sold during the previous tax year, that had been held for more than one year.
How Does This Affect my Taxes?
Long- term gains can have a significant impact on your tax liability, because they are taxed at lower rates than short- term gains. With a short- term gain, you have to pay taxes at a rate equal to the rate on your regular income. This can be as high as 39.6%, if you're in the top bracket. But, with a long- term gain, the tax rates are lower. If your regular tax bracket is 15%, then your long- term tax rate is reduced to 10%. If your regular tax rate is 28% or higher, then your long term gains tax rate is cut to 20%.
Effective Dec. 31, 2000, congress has added another incentive, for long- term investors, which reduces the long- term gains rate even further. If an asset has been held for over 5 years, then the tax rate is reduced to 8% (for taxpayers currently in the 15% bracket) and 18% (for taxpayers in the 28% bracket or higher). There is one catch to this: if you are currently in the 15% bracket right now, then this new law takes place retroactively, for any asset sold on Jan. 1, 2001 or later, so you can take advantage of the lower rate immediately. But, if you are in any other bracket (and most taxpayers who have long- term gains are in a higher bracket), then the change does not take place retroactive. You would have to wait until Jan. 1, 2005, to sell your asset (acquired on Dec. 31, 2000 or earlier) if you wanted to take advantage of these lower rates.
Lower taxes are the main reason to hold assets for more than a year, especially of you're in a higher tax bracket. For those in lower brackets (or in the zero bracket), the differences between short and long term rates isn't as significant. But this tax savings is only part of the picture. When you are evaluating whether or not to sell an investment in the short- term, you have to think about where the price is at currently, and where you think it's heading. During the year 2000, internet stocks took a beating, with many of them losing 90% or more of their value. Some of these shareholders saw that the market for "dot com's" was beginning to show signs of a bear market, but they didn't sell, hoping that the prices would rebound and they could avoid paying a short- term gain tax. I'm sure these investors are kicking themselves now! With many internet stock prices plummeting to all time lows, these investors would have been better off if they had just sold their stock and paid the higher short- term gain tax.
One other thing to remember is that these tax laws can change at any time. With all the "tax talk" currently going on in Washington D.C., who knows what could happen to short term and long term tax rates? They might be lowered even further than they are now; they might go up; and they might be completely restructured, which would change everyone's tax strategy overnight. So, before you make a decision, always consult a tax professional, a broker, or the world wide web, to get up to date tax information. With taxes, it's better to be safe than sorry.
For more information on federal income taxes, be sure to read the following essays:
Federal Tax Withholding
Short Term Capital Gains and Losses
Capital Losses and Tax Treatment
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