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Assets fluctuate in value all the time, and as their prices change, capital gains and losses accumulate. Income produced as a result of the sale of a capital asset must be reported on your income taxes as a capital gain. The amount of the reported capital gains depends on how long you have held the asset, the original purchase price, sale price and your income tax bracket. Income from daily trading is considered as short term gain or business income. Those accrued losses and gains are not realized, however, until the assets are sold and the former owner captures the gain (or loss).
Capital gains and losses are classified as long-term or short-term , depending on how long you hold the investment before you sell it. If you hold it more than one year, your capital gain or loss is long-term. Long-term are taxed at 15% or 5% depending on your tax bracket. Long-term losses are applied to long-term gains. The result is net long-term capital gain or loss. Long-term capital gains, however, are taxed at a lower rate. Long term capital gains are taxed at a rate of 15% through 2010. Long-term capital gains on collectibles, some types of restricted stock, and certain other assets are instead subject to a minimum 28% rate. Short-term capital gains are taxed at the same rate as your ordinary income. Short-term capital gains are those that you earn on sales of one year or less. Short-term capital gains are taxed at the taxpayer’s regular tax rates. Before the 2003 Tax Act, long-term capital gains were taxed at 20% for taxpayers in the 25% or higher tax bracket (10% for individuals in the 10% and 15% marginal tax brackets).
Taxpayers respond significantly to incentives: if they know taxes will rise in the future they will accelerate income and accelerate the realization of gains. Tax managed funds are run with an eye towards after-tax returns. Unlike tax friendly funds, most mutual funds are managed without regard to taxes. Investors are expected to pay taxes on gains even though average mutual funds declined significantly during this economic downturn. After taking massive hits to their portfolios, investors who are expected to pay capital gains even though they have sustain such drastic losses could find this a very bitter pill to swallow. Investing in a large number of assets, or diversification, means that a loss incurred on one investment is minimized by gains in others. Investors have watched as the worst bear market since the Great Depression has savaged their savings and plundered their pensions.
Only careful planning, patience, and time will get us out of this capital gain loss debacle.
