Capital Gains Treatment

DEFINITION of 'Capital Gains Treatment'

Capital gains treatment are specific taxes assessed on investment capital gains as determined by the U.S. Tax Code. When a stock is sold for a profit, the portion of the proceeds over and above the purchase value (or cost basis) is known as capital gains. Capital gains tax is broken down into two categories: short-term capital gains and long-term capital gains. Stocks held longer than one year are considered long term for the treatment of any capital gains, and are taxed a maximum of 15% depending on the investor's tax bracket. Stocks held less than one year are subject to short-term capital gains at a maximum rate of 35% depending again on the investor's tax bracket.

BREAKING DOWN 'Capital Gains Treatment'

The huge difference between the short-term and long-term rates makes it clear that paying close attention to the tax consequences of investing in stocks is a critical skill to develop. As an investor's portfolio grows, he or she should increasingly keep track of capital gains, including making adjustments near the end of the calendar year to reduce capital gains taxes as much as possible. An accountant or investment professional can assist in these efforts.

How the Holding Period Can Affect the Capital Gains Treatment

The holding period for a stock, the time frame it is owned, typically begins from the day the stock is held by the investor regardless of how long any warrants or options awaited to be exercised. In many instances, the stock is held at least one year and a day in order to receive the preferred long-term capital gains treatment. There may be instances, such as if the stock is expected to decline deeply, where it can be more advantageous to investors to sell those shares and pay the higher capital gains tax rate rather than face even deeper losses.

There are cases where the holding period to receive long-term rates follow different rules. For example, if an individual were to inherit stock or other applicable assets, they would automatically receive the preferred long-term rate. If an employee is granted an incentive stock option, they must wait at least two years from the date the options were issued and at least one year from when the option was exercised and the stock came into their possession. When stock is gifted to another person, the time the shares spent in the possession of the person granting the stock would be included in the overall holding period.