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Capital Gains Tax is a tax that we hate hearing about yet hits many of us at one time or another when we make a profit on a sale. There are different tax brackets for capital gains depending on how long the investment is. Uncle Sam favors investments that are held on a long-term basis such as over a year. In spite of the fact that we hate capital gains tax, many investors feel they are preferable to income tax.
An individual can purchase stocks for the same dollar amount yet pay different capital gains tax depending on the length of time the stocks were held. For instance, a man can purchase $1,000 in stocks, keep it for 6 months and then sell it for $160,000, making a $159,000 profit (before capital gains tax). The same man call buy $1,000 in stocks, keep it for 6 months and sell it for $150,000, a profit of $149,000 (before capital gains tax). While it may appear that the first purchase reaped the larger profit, this is not the case.
Saying that the individual's normal tax bracket is at 28%, the short-term capital gains rate will also be for 28%. The long-term capital gains rate for that same 28% income tax bracket will be 15% vs. the 28% on the profit. Make Sense? By merely holding the investment over a year, your capital gains tax rate goes from 28% to 15%.
You can now understand why it will usually make more sense to hang onto an investment at least over a year as it may make a substantial difference in the amount of capital gains tax you pay. There is often the situation where your investment has made a huge jump in the first 8 to 9 months of obtaining it. While you realize the importance of waiting one year to sell it, in terms of capital gains rate, you're concerned that the value may plummet before the year is up. You have to figure out what your bottom dollar figure will be. By this, I mean, how low the value can go down before you break even regardless of what tax bracket you're in for capital gains tax. If you familiar with a tax expert or financial advisor, they can be very helpful in situations such as this.
The advantage of capital gains tax rates over regular income tax is the tax bracket. Regardless of the income means, our tax bracket is what it is. The capital gains tax bracket, as you've seen changes based on whether it's long term or short term.
The Tax Reconciliation Act, which was signed into law in 2006 by President George W. Bush resulted in the reduced 15% capital gains tax rate for long term investments be extended through 2010. From 2003 through 2007, those in the two lowest income tax brackets have a capital gains tax rate of 5%. From 2008 through 2010, the long term capital gains rate for those in the 10% and 15% income tax groups is 0%.
Usually, in determining the taxable amount of the game, a cost basis is used as opposed to the actual purchase price of the investment. The cost basis is based on what you paid for the item plus or minus any adjustments that have been made such as improvements, taxes paid on dividends, depreciation, etc.
An interesting fact is that the United States is the only country that makes their citizens subject to U.S. tax on income, regardless of where they live in the world or where the investment is. If you're a United States citizen, you pay the tax.
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