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What is a Long Term Capital Gain

Long Term Capital Gain Definition

When evaluating the federal tax consequences of a capital gain, the IRS requires that you calculate your holding period for the transaction’s underlying property so that you can identify whether to report it on Schedule D as a long term capital gain or as part of your short term capital gains. This is because the rate of tax you will pay on a capital gain is different depending on how long you own the property before selling it. If you own a capital asset for more than one year before selling it, the IRS treats the profit as a long term capital gain—and you must identify it as such when reporting it on Schedule D. For all other capital asset sales, report them on Schedule D as short term capital gains.

Long Term Capital Gain Taxes

The federal income tax law imposes lower rates of tax on a long term capital gain than it does on your short term capital gains. The long term capital gain rates can change frequently, but through the end of 2012 you will pay either 0 or 15% in tax. However, your short-term gains are taxed at the same rates as the rest of the gross income you report on the first page of your 2011 1040 form. For example, if you purchase stock on Jan. 1 and sell it on Dec. 31 of the same year, your holding period is short term. But if you wait until Jan. 1 of the next year to sell the shares, the holding period changes to long-term. This holding period is only significant if the sale of your capital asset results in a gain since both short term and long term capital losses are treated the same for tax purposes—with the only distinction being whether it relates to the sale of investments or personal property.

Long-Term Capital Gain Calculation

An essential component of any capital gain calculation is the tax basis you have in the capital asset you sell. Your tax basis in a capital asset is essentially equal to its purchase price. However, in many cases, it includes additional amounts. For example, when you purchase a share of stock from your broker, your tax basis in the stock is equal to the market price available at the time your broker executes the trade plus the brokerage commission. When you eventually sell the stock, the broker is going to charge you a second commission that will increase your tax basis. You then calculate your long-term capital gain by subtracting the final tax basis from the market price you sell the stock for.

To illustrate, suppose you purchase one share of stock for $100 and your broker charges a $5 commission. If you hold the stock for more than one year before selling it at a market price of $150 and paying a second brokerage commission of $5, your long term capital gain is $40.

Reference: IRS Publication 544 – Sales and Other Dispositions of Assets