Capital Gains Federal Tax

A capital gain is merely the distinction between the purchase and selling price of an asset. In other words, selling price - purchase price = capital gain. What tax collectors are looking for is a cut of your income, or rather, your income tax. When they get a cut of any gains you make on your investments, that cut is called a capital-gains tax.

For tax purposes, it is important to understand the difference between realized and unrealized gains. A gain is not realized until the security that has appreciated is sold. Although your investment has increased since the day you bought the shares, you will not realize any gains until you have sold them.

As a general rule, you don't pay any tax until you've realized a gain - after all, you need to receive the cash (sell out at least part of your investment) in order to pay any tax.

In the US, individuals and corporations pay income tax on the net total of all their capital gains but the tax rate for individuals is lower on long term capital gains. However, short term capital gains are taxed at a higher rate which would be the normal income tax rate. In 2003, the tax rate on long term gains was reduced from between 15% to 5% depending on the investor's tax bracket. That rate has been extended through 2010 as a result of the Tax Increase Prevention and Reconciliation Act. Beware that in 2011, these reduced rates will revert back to around 20%.

Individuals only are allowed to defer capital gains taxes using strategies such as the Structured sale, charitable trust or a 1031 exchange which are all run by the IRS.

Capital gains are clearly a good thing, but the tax you have to pay on them is not. The two main ways to reduce the tax you pay are to hold stocks for longer than one year and to allow investments to compound tax free in retirement-savings accounts. The moral of the story is this: by adopting a buy-and-hold mindset and taking advantage of the benefits of retirement plans, you are able to protect your money from the government and enjoy the power of compounding your investments at the same time.

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