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Even if you aren't a long-term investor, you're probably familiar with the concept of gains and losses. From a tax perspective, you don't really have a gain or a loss on an investment until you "realize" it. Realized gains and losses are reported on your taxes and can raise or lower your tax bill, depending on how you use them.
Realized Gain and Loss
To realize a gain or loss mean to record it via a sale. If you have a gain on paper but haven't yet sold the asset, you're gain is an unrealized gain. Unrealized gains fluctuate from moment to moment along with the daily market trend, but realized gains are permanent and specific. The same holds true of realized losses, which result from selling an asset at a loss. Once you realize a gain or loss, its value is fixed and cannot be changed.
Short-Term Vs. Long-Term
A short-term gain or loss results when you sell a security one year or less after you purchase it. If you've held an asset for longer than one year, you have a long-term transaction. The differentiation between long-term and short-term gains and losses is important when you file your taxes. Long-term gains typically benefit from a lower tax rate than short-term gains.
As of 2012, the maximum tax rate on long-term capital gains is 15 percent. For investors in the two lowest tax brackets, the capital gains rate drops to zero percent. Short-term gains are taxed as ordinary income. You'll pay the same tax rate on your short-term gains as you would on your wages or salary. Since the top federal tax bracket as of 2012 is 35 percent, a short-term gain would cost you an additional 20 percent in tax over a long-term gain.
To lower your tax bill, you can use your realized losses to offset any realized gains. If you have additional losses above and beyond your gains, you can take an additional $3,000 per year off your ordinary income for tax purposes. Excess losses can be carried forward for use in the same way in future years. If you have unrealized gains approaching the one-year mark, you may consider holding those assets for a few additional days to cross into long-term territory before you realize them.