Long-Term Capital Gain Rules
A capital gain is a profit you make on a capital asset. Capital assets are investments such as stocks, bonds or real estate. The Internal Revenue Service (IRS) categorizes capital gains as either short- or long-term. In order to encourage long-term investments, the tax rate on long-term capital gains is usually less than that of short-term capital gains.
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Duration
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The distinguishing characteristic between long-term and short-term capital gains is the duration of your ownership of the investment. Assets that you sell less than a year after you purchase them are considered short-term capital gains. To qualify for a long-term capital gain, you must own an investment for longer than one year.
Taxation
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One of the benefits of a long-term capital gain is that you don't owe any tax until you sell it. The other primary benefit is that long-term capital gains have their own tax structure. While the rates can change from year to year, at the time of publication the maximum long-term capital gains tax rate stands at 15 percent. For taxpayers in lower-income tax brackets the capital gains rate could fall all the way to zero. If you take a short-term capital gain, on the other hand, your tax rate is the same as your ordinary income rate. In most cases this is higher than the long-term capital gains rate.
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Offsetting Gains and Losses
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While taking a long-term capital gain is a taxable event, you may be able to use your capital losses to minimize or eliminate your tax liability. The IRS allows you to match up your long- and short-term capital gains to calculate a net capital gain. If your losses exceed your gains, you do not have to pay tax on any of your gains. You can even take $3,000 of excess losses to reduce the amount of your ordinary taxable income.
Exceptions
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The long-term capital gains tax rates apply to almost all types of capital gains. Certain exceptions are taxed at higher rates of 25 or 28 percent. Certain small business stock known as Section 1202 stock is taxed at the higher 28-percent rate, as are collectibles such as art. Real property falling under Section 1250 recapture rules is taxed at 25 percent.
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