Long term & short term capital gain and loss

When it comes to taxation of investments, it makes a difference whether your capital gain is long term or short term. Capital gains from long-tem investments are taxed differently from short-term investments. Short-term investment gains are usually taxed more than short-term profit.

How is short-term capital gain defined?

The holding period is determined by subtracting the date you bought your investment from the date you sold your investment.

The short-term holding period is defined as one year or less. Short-term capital gains are taxed at ordinary income tax rates.

When you hold your assets more than one year, then your capital gain is considered long-term. Long-term capital gains are taxed at discounted long-term capital gains rates. Depending on your marginal tax bracket, the long-term capital gain tax rate is either 5% or 15%.

Example...

Let us take a look at an example. Joe Smith invests in XYZ stock on March 15, 2008. Then he sells the stock on March 15, 2009. Joe's holding period for the stock is exactly one year, and this investment would be considered a short-term investment. The tax code goes by years in this case and not by how many days there are between the dates.

If Joe sells his stock on March 16, 2009, his holding period will be one year and one day which would be considered a long-term investment.

Calculation of dates is important for leap years. If you buy your stock on February 29th one year, you have to wait until March 1st the following year for it to be considered a long-term investment. If you sell your stock on February 28th the following year, it will be counted as short-term investment.

Tip: Some times it pays to do your planning and to defer the sale of a profitable investment until you qualify for the discounted long-term capital gains tax rate.

How do I calculate capital gains?

The principle of calculating capital gains is easy. It is much easier than the administration and bookkeeping that surrounds it. Profits or losses from investments need to be calculated per each round sale that is made.

sale price 
- selling fees & commissions
- purchase fees & commissions 
- purchase price
= capital gain (or loss if negative)

So far it is easy. The Form 1040 Schedule D however does not provide any box where you can provide information about fees and commissions. The easiest way to account for fees and commissions is to combine all commissions, fees, and the purchase price together into one figure called cost basis. Cost basis is the purchase price plus purchase and selling fees and commissions.

That leads us to the final formula for capital gain calculation which is the following:

selling price
- cost basis
= capital gain (or loss if negative)

It is easy.

Where in my tax return do I include information about my capital gain?

The Schedule D is organized much like a spreadsheet. Capital gain or loss is reported for each transaction. In case you need more space to list all your transactions, you can use the Form 1040 Schedule D-1 Continuation Sheet for Schedule D to provide information about items that do not fit on the Schedule D.

Once your total gains or losses are figured, you write the final number on the proper line in the Income section of your 1040.

Anything else I need to consider?

If you are a bad stock market player and loose more than you make, know that there are special rules for capital losses, such as annual limitations on capital losses and Wash Sale Rules.

You might be also interested in the 10 tips last-minute checklist for error-free tax return.

How do I tax long term & short term capital gains?

You can find that on the next page: Capital gains tax rates

If you need more information about taxes, or if you want to ask a question, you are welcome to visit our taxes discussion forum, or some of the resources below might be able to help too.