Shares of stock are "capital assets," according to the Internal Revenue Service (IRS). That means that if you sell them for more than they were worth when you acquired them, you've realized a "capital gain." Capital gains are subject to income tax, though usually at a lower rate than other income.
Capital Gains and Losses
Whether you have a capital gain on the sale of shares depends on how much you sold them for compared with the "basis," or how much they were worth when you acquired them. If you bought the shares, the basis is simply the purchase price. If you inherited the shares, received them as a gift or acquired them some other way, your basis is their market value at the time you received them. Regardless of how you got the shares, if you sell them for more than the basis, you have a gain, and you may have to pay taxes. If you sell the shares for less than the basis, it's a "capital loss" -- and not only is there no tax on the sale, there's a tax benefit to soften the blow.
Short-Term vs. Long-Term
The IRS defines your capital gain on a stock sale as either "short-term" or "long-term" depending on how long you owned the shares before you sold them. If you had them for a year or less, your profit is a short-term gain. If you held them for more then a year, then you have a long-term gain. Under the same timeline, if you sold the shares at a loss, your loss is either short-term or long-term, depending on how long you owned the shares.
Figuring the Rates
Federal tax rates on capital gains depend on two factors: your "tax bracket" -- that is, the highest rate you pay on any portion of your income -- and whether the gains were short-term or long-term. Short-term gains are typically taxed at your tax bracket rate. As of the time of publication, there are six brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent and 35 percent. Long-term gains are usually taxed at a lower rate -- and for some aren't taxed at all. As of the time of publication, for example, people in the 10 percent and 15 percent brackets paid no tax whatsoever on long-term capital gains, while people in the other four brackets paid 15 percent on long-term gains. Capital gains rates have changed repeatedly over the years. From 1988 to 1997, for example, the top rate on long-term capital gains was 28 percent; from 1998 to 2002, it was 20 percent.
Reporting Gains and Losses
Use IRS Schedule D to report your gains and losses from selling shares, plus any other capital gains and losses you may have. On this form, you can use any short-term losses to offset your short-term gains, and any long-term losses can offset long-term gains. After doing that, you add the short- and long-term totals together. If there's a net gain, you'll be paying tax on it. If there's a net loss, you can use it to offset your other income, up to a maximum of $3,000 a year. For example, if you have $50,000 in other income and $10,000 in losses on stock sales, you could use $3,000 of your loss to reduce your total income to $47,000. When your losses exceed $3,000, you can "carry forward" the extra loss into future years, at a maximum of $3,000 per year. In the case of a $10,000 loss, then, you could claim a $3,000 loss for three straight years, then a $1,000 loss in the fourth year.
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