What is a Short-Term Gain?
Short-term gain usually refers to the profit on the sale of an investment that has been held less than a certain IRS-defined period of time.
How Does a Short-Term Gain Work?
Let’s assume you purchase 100 shares of Company XYZ for $1 per share. After three months, the share price increases to $5. This means the value of the investment has increased from $100 to $500, for a capital gain of $400.
Taxpayers report capital gains on IRS Schedule D, but these gains are subject to different tax rates depending on whether they are short-term or long-term (and in some cases depending on the type of asset). In the example above, if you sold the Company XYZ shares after a year, the IRS would consider your $400 profit a long-term capital gain and tax it at one of several flat rates. However, if you sold the Company XYZ shares after just three months, the IRS would consider your $400 profit a short-term capital gain and tax that $400 at your ordinary income tax rate, which varies by several factors, including which state you live in, and is generally higher than the long-term capital gains tax rate.
Why Does a Short-Term Gain Matter?
Establishing a higher tax rate for short-term capital gains encourages long-term investing, but there are still many logical reasons why an investor might want to sell an asset before a year has passed.
An investor’s capital losses sometimes offset all or a portion of his or her capital gains, lowering the investor’s tax bill. There is a limit, however, to how much the investor can offset. Investors should seek the advice of a competent tax professional to understand how capital gains treatment affects specific investment decisions.