Short-Term vs Long Term Capital Gains

A capital gain is an increase in the value of an asset that occurred over time. The difference between short-term and long-term capital gains lies within the amount of time the asset was held before it was sold.

What Is Short-Term Capital Gain?

Short-term capital gains are the difference in price between when an asset was purchased and when it is sold. If this difference is negative, the owner of the asset actually lost money instead of making a profit. Short-term capital gains are taxed at different rates depending on how high your income is, with higher tax rates being applied to individuals with higher incomes. Short-term capital gains are usually taxed as ordinary income, but there is a chance that low-income earners might have to pay a higher rate of tax. Individuals with incomes less than thresholds must file Form 1040 and those above the threshold may also have to file Form 8949. The difference between short-term and long-term capital gains lies within the amount of time the asset was held before it was sold. Short-term capital gains result when an individual holds onto their assets for less than one year before they are sold, while long-term capital gains occur when an asset is held onto for more than one year.

What Is Long Term Capital Gain?

Long-term capital gain is the difference in price between when an asset is purchased and when it is sold. If this difference is positive, the owner of the asset actually made a profit instead of losing money. Long-term capital gains are taxed at a lower rate than short-term capital gains, but the difference in tax rates varies depending on how high your income is. Both short-term and long-term capital gains are taxed as ordinary income.

Tax Implications for Each Type of Gain

Short-term capital gains are taxed at your normal income tax rate while long-term capital gains are taxed at a lower rate. Therefore, if you have a higher income, the difference in taxes will be greater. For short-term capital gains, this is how your taxes will be completed when you submit your return by May 17, 2021. Short-Term_Capital_Gain_Tax_Completion Long-term capital gains are taxed at 0%, 15%, and 20% of taxable income, respectively. Long-Term_Capital_Gain_Tax_Completion

How to Make the Most Out of Your Tax Return 

You can save money by carefully choosing which gains to report. If you have both short-term and long-term capital gains, you can choose what percentage of each to report by multiplying the total amount for both types of capital gains by whatever number is closest to your desired ratio. The difference in tax rates between the two determines how much money you will be able to save or lose by making this decision.   For example, if you have $100 in short-term capital gain and $200 in long-term capital gains, you can choose to report half of each type (50 percent short-term and 100 percent long-term) instead of reporting all of them together. This way you can lose or save $20. If you have more than one asset, it might be beneficial to sell the ones that are long-term before selling those that are short-term. For example, if you own $100 in short-term capital gains and $300 in long-term capital gains, you can choose to report all of the short-term ones and none of the long-term ones. This will result in $20 less than if you had reported half of each type of capital gain. These are two scenarios for your tax return. The difference between them is whether or not they include short-term gains, which could save you up to $20 depending on how much you earn. If you report both short-term gains, you must pay taxes at your normal income tax rate. If you only report long-term capital gains, then you must pay taxes on that difference.

How to Avoid Paying More Taxes Than Necessary

It might be in your best interest to hold onto assets with short-term gains for longer to pay the lower tax rate. If you are planning on selling any of your assets in order to make money, it is in your best interest to consult a professional before doing so. If you plan to sell an asset at a profit, it will be beneficial for your wallet if you do not sell it within one year of buying it. Instead, you should keep it for longer than one year in order to receive the difference in tax rates. For example, in the scenario above in which you have $100 in short-term gains and $300 in long term gains, if you sell all of it within one year, then pay your normal tax rate instead of the difference between short-term and long-term capital gains, you would lose $20. If you hold onto the asset for more than one year, then pay the difference between short-term and long-term capital gains, you would save $20. This is an example of what you should do if you are planning on selling any assets in order to make money. You should hold onto your assets for more than a year before selling them in order to take advantage of the difference in tax rates.

The Bottom Line

Whether you have a higher or lower income, it is beneficial to take advantage of the difference in tax rates between short-term and long-term capital gains. By doing this, you can save up to thousands of dollars depending on how much money you make. If you are planning on selling an asset at a profit, then you should hold onto your assets for more than a year before selling them in order to take advantage of the difference in tax rates. Remember that you can save money by carefully choosing which gains to report on your tax return. You can choose what percentage of each type you wish to include based on how it will affect your wallet.

Capital gains are the difference in price between an asset when it was bought and the amount it is sold for.
A short-term capital gain is any difference in price that occurs within one year of buying an asset.
A long-term capital gain is any difference in price that occurs after one year of buying an asset.
If you opt to report short-term gains, then you will pay your normal income tax rate on them. If you only report long-term gains, then you must pay the difference in tax rates.
By carefully choosing which gains to report on your tax return, it is possible to save thousands of dollars. You can choose what percentage of each type you wish to include based on how it will affect your wallet.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.