Long Term Versus Short Term Capital Transactions

Net Capital Gains

The test for determining whether an asset sold is being disposed of as a short-term capital transaction or a long-term capital transaction is simple.  If the holding period is more than a year, it is considered long-term, while anything less is considered short-term.  So, if a stock was purchased on March 15, 2008, it would need to be held until March 16, 2009, in order to be considered a long-term asset.  Even on March 15, 2009, it would be considered short-term.  As there are usually substantial benefits for long-term transactions in the US tax code, it is usually worthwhile in such situations to hold on an extra couple of days for it to qualify as long-term.

The most common of the benefits long-term capital gains qualify for is the 5%/15% gain rule, referring to the taxation rate applied to the gain.  If the taxpayer’s income is normally at or below the 15% tax rate, only a 5% payment is necessary, while a taxpayer with a normal taxation rate over 15% is required to pay 15%.  In 2009, the cutoff point was income up to $33,950 for single taxpayers or married filing separately, while married filing jointly was at $67,900.  This is a sharp contrast to the rules for short-term capital gains, which receive no special treatment and are taxed at the same rate as the rest of the taxpayer’s income.

There are a few other possible taxation rates, at the 25% and 28% level, but these are much less common.  25% gain deals with the sale of specific assets recognized under Sections 1231 and 1250 of the tax code, while 28% gain specifically applies to the sale of collectibles.  We will be adding a follow up article at some point to discuss what exactly these rates apply to, but for now if you’re only dealing with common securities like bonds and stocks these special rates do not apply to you.

Net Capital Losses

Note that regardless of whether a net capital loss is short-term or long-term, only $3,000 can be deducted in any given year.  However, these deductions do carry forward, allowing a much larger capital loss to be deducted over many years, or directly offset by any capital gains that the taxpayer might earn.  Whether the gain was long-term or short-term should still be recorded, as the ever-changing tax laws might change the method of their disposal at some point in the future.  When both long-term and short-term capital losses exist, short-term losses are deducted first.