What are Short-Term Capital Gains?

Short-term capital gains represent money that you’ve made through investments that have run their course over a relatively small period of time. For some people, taking this investment route is beneficial, while others feel it can be detrimental tax-wise. Let’s look more closely at this concept:

The Basics

When making investments in mutual funds, your representative company will buy and sell securities in order to increase the value of your fund, which in turn increases your gains. In an effort to avoid paying taxes after the money has been made, the company will then pass along most gains to the shareholders once a year. But investors unfortunately have to foot the bill in taxes. The amount of taxes paid varies depending on whether the investor has created long or short-term capital gains. Let’s briefly look at the difference between the two.

Long Term vs. Short Term

When making investments, some prefer choices that will either result in long-term capital gains or short-term capital gains. Those considered short term are the investments that you’ve held for one year or less while long term stretches out beyond one year. To determine which category you fall into, you begin counting your holding period on the day after you acquire an asset. The day that the holding period ends is the day that you sell. So if you’re on the brink of one year and are not sure when category you fall into, this is a great way to tell.

Tax Liabilities

Much of what plays into this decision of which type of gain to go with comes from taxes. Traditionally, short-term capital gains result in higher taxes. In fact, if you engage in a shorter investment period, you might be taxed up to 35%, and that might not include your state’s taxes, which is not a great financial decision for many.

In addition, some are benefiting from a new zero percent tax that was created in 2008 for long-term capital gains, which is moving them away from shorter investment periods. It applies to individuals who are in the 10-15% marginal tax brackets. However, the tax is expected to be short-lived as it is set to expire in 2010, at which time rates will increase.

When making investments many experts ask investors to shy away from short-term capital gains if they want to avoid major taxes. But if you feel this is the best route to take, yet you still are looking for a way to avoid major taxes, you can strategize by taking on a charitable trust or participating in a 1031 exchange.