What are the Tax Implications for Short Term Gains and Losses?
Jan 14 '02 (Updated Apr 15 '09)
The Bottom Line Short- term gains and losses apply to assets held less than 1 year and they generally carry a higher rate of tax than long- term gains and losses.
Taxable gains and losses represent the increase or decrease in value, and the resulting gain or loss that is incurred, when you sell an asset. These gains and losses, depending on the length of time that has elapsed between the purchase and sale date, can sometimes have a substantial impact on the amount of federal tax owed.
What are Short- Term Gains and Losses?:
Short- term gains and losses are defined as the money gained or lost on the sale of an asset that has been held for less than one year. For tax calculations, this would apply to any type of capital asset, like common stock, corporate bonds, etc. It also includes any item that relates to your personal business (if you own a small business), like industrial equipment, delivery vehicles, etc.
Tax Implications:
The main reason why short- term gains and losses have significance is because they are generally taxed at higher rates than long- term gains and losses. When you sell stock, for example, held for less than one year, the resulting gain or loss is going to be taxed based on your current marginal tax rate, which can be anywhere from zero to 39.1 percent.
Before you assume that you will have to pay a large amount of tax on your short- term gain, remember that you first must net your gain with any short- term losses for the year. If you have a large gain for the current tax year, but also a loss from the sale of another capital asset, then your loss will need to be subtracted first, from the gain, to find your net gain/loss for the year. The amount of net short- term gain will then be taxed at your marginal tax rate. If losses exceed gains, then you can carry the losses forward, to offset the next year's income.
Are There Any Exceptions?:
Certain types of gains and losses are going to be treated differently, regardless of whether or not the gain is short term or long term. For 2001, these three exceptions exist:
Small Business: If you experience a gain from qualified small business stock, it will be taxed at a maximum rate of 28 percent, regardless of your marginal tax rate.
Collectibles: Sales of art, coin collections, antiques, etc., are all taxable at a maximum rate of 28 percent, regardless of your marginal tax rate.
Property: If you make a net capital gain from the sale of section 1250 real property that is due to prior depreciation, the maximum tax rate is 25 percent.
What's the Tax Difference?:
Whether or not your gain is short- term or long term makes little difference in some cases, and a great difference in others. If your gains for the year are typically small (like a few thousand dollars or less), and/or your marginal tax rate is low, then it won't make much difference if your gain is short- term or long term.
On the other hand, if you make very large gains for the year and/or your marginal tax rate is high, then the term that you held your assets can make a significant difference in your tax calculations.
Let's take a look at an example: Let's say that you had net capital gains for the year that totaled up to $20,000. You are in the highest tax bracket, which is 39.1 percent for 2001. If these gains were all short term, then your tax would be quite high: .391 (20,000) = $6,820. If, however, you had held these assets for more than a year, then the maximum capital gains tax rate of 20 percent would apply, which would lower your Federal tax owed on your gain to: .20 (20,000) = 4,000. That represents a tax savings of $2,820.
Final Thoughts:
Short- term gains should be avoided, whenever possible, to minimize your tax burden. Obviously, we cannot always avoid short- term gains. An emergency situation could arise during the year, forcing an individual to liquidate some assets much sooner than he/she would had originally planned.
Stretching out the holding period to more than one year will qualify the gain as long- term, and possibly lower your tax. If your marginal tax rate is already less than 20 percent, then it won't make any difference whether or not the gain is short term or long term. You won't need to worry about when you sell your investments or capital assets.
If your tax margin is higher than 20 percent, then try to hold off on making a sale, until the 1- year anniversary of the acquisition of the asset has been reached. This will help you to minimize your taxes, and keep Uncle Sam from seizing more of your earnings.
For more information on federal income taxes, be sure to read the following essays:
Federal Tax Withholding
Federal Exemptions
Long Term Capital Gains and Losses
Capital Losses and Tax Treatment
Standard Deduction
Charitable Contributions
Interest Income
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