What Is a Short-Term Capital Gain, How Much Is It, and How Is It Taxed?

What Is a Short-Term Capital Gain, How Much Is It, and How Is It Taxed?

Posted by on Dec 6, 2020

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A refresher on how short-term capital gains work and how they are taxed is useful for investors seeking to minimize the tax implications of investment decisions. If you are contemplating the sale or purchase of property or another investment asset, you may decide to alter the timing based on whether a shift can move a gain from the short-term category to long-term.

What Is a Short-Term Capital Gain, How Much Is It, and How Is It Taxed?

A refresher on how short-term capital gains work and how they are taxed is useful for investors seeking to minimize the tax implications of investment decisions. If you are contemplating the sale or purchase of property or another investment asset, you may decide to alter the timing based on whether a shift can move a gain from the short-term category to long-term.


What Is Capital Gain?

In general, a capital gain is an increase in a capital asset's worth over its basis. An asset can be property or an investment. The basis (sometimes referred to as tax basis) is the original cost plus any out-of-pocket expenses like closing costs. 

For example, if a taxpayer buys property for $2,000,000 plus $100,000 in acquisition expenses, the property's basis is $2.1 million. Other adjustments, such as depreciation, can be calculated over time, but these are unlikely to be relevant for a short-term capital gain.


Short-Term Capital Gain

Capital gains are short-term if the taxpayer holds the asset for one year or less, and the profit will be subject to the investor's ordinary income tax rate. The calendar starts running on the day after the investor acquires the asset. This date can go up to and include the day the investor disposes of it. 

An example of a short-term capital gain is buying a stock at $100 and selling it at $105 in three months. Because the stock was held for less than a year, the $5 gain is taxed at the ordinary income rate.


Long-Term Capital Gain

A long-term capital gain occurs on investments held for more than one year. Rather than being taxed at the ordinary income tax rate, these gains are taxed at lower rates, depending on the investor’s adjusted gross income.

Long-term capital gains rates for 2021 are as follows:

Capital Gains

Tax Rate

Taxable Income

(Single)

Taxable Income

(Married Filing Separate)

Taxable Income

(Head of Household)

Taxable Income

(Married Filing Jointly)

0%

Up to $40,400

Up to $40,400

Up to $54,100

Up to $80,800

15%

$40,401 to $445,850

$40,401 to $250,800

$54,101 to $473,750

$80,801 to $501,600

20%

Over $445,850

Over $250,800

Over $473,750

Over $501,600

An example of a long-term capital gain is a stock purchased at $100 and sold at $105 fifteen months later. Because the stock was held for more than a year, the $5 gain will be taxed at the lower long-term capital gains rate.

A "buy and hold" strategy (i.e., long-term)  in equity investments has a more favorable tax treatment than one which involves more frequent transactions—like day trading. However, short-term losses are initially deductible against short-term gains before being deducted from long-term gains. This rule means that if you have a larger short-term loss, you can subtract it from the gain that is likely subject to the higher tax rate of ordinary income. 

You may want to consider timing the realization of losses to balance short-term gains if possible. Also, a loss that is not fully offset by increases in one tax year can be carried over to another year, subject to some limitations and specific provisions.


Will a Short-term Capital Gain Push My Ordinary Income Into a Higher Tax Bracket?

No, because U.S. income taxes are progressive. As a taxpayer, you pay taxes on your ordinary income at the rate for the bracket the income belongs to. Suppose you have $100,000 in income from wages and $20,000 in gains from short-term investments. Tax rates on your ordinary income will range from the lowest 10% rate for the first $9,875 up to 24% for the amount between $85,525 and $100,000. The $20,000 of the short-term gain will fall into that 24% category as well. The higher income is taxed at the higher amount, but having the income reach the higher bracket doesn't change the tax rate on the lower amounts. 

Now consider a scenario in which an investor deferred the asset's sale that netted them a $20,000 gain until it became a long-term gain instead of short-term. Rather than being subject to a 24% tax rate as ordinary income, The IRS would tax the $20,000 at 15%. The tax bite drops from $4,800 to $3,000. This example is just an illustration, of course, and we always recommend that you consult a tax advisor for specifics. The takeaway is that the tax code is meant to encourage holding assets rather than frequent transactions. 

 

This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.

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