investing guide

How Do Capital Gains Taxes Work

capital gains tax

So how do capital gains taxes work?

As with most other forms of income in life when you make money trading securities that money is taxed. There are two types of income related to trading stocks.

The first is ordinary income which consists of dividends or interest income.

The second is known as capital gains which is when you sell a stock or security for a profit.

Capital gains are only taxed after you actually sell the stock or security you own. Another important aspect related to capital gains tax is that if you hold a security for less than a year, which is known as a short-term capital gain, it is taxed at the same rate as your ordinary income is taxed. However, if you hold a security longer than a year, which is known as a long-term capital gain, the tax rate on those securities is less. The tax rate varies depending on your income, but your tax savings on a long-term capital gain can range from 5%-20% depending on your tax bracket.

So does this mean you should always hold a security for at least a year. I guess that depends on your personal beliefs on being taxed. I personally think it is silly to risk a huge gain going down in price simply to wait a year to get a tax break.

In addition to being taxed on capital gains there is also what is known as a capital loss. Investors are allowed to claim up to $3,000.00 dollars a year against their ordinary income when they lose money trading securities.

Please remember to talk to a tax professional especially if you have never traded securities before.