The best benefit of a long-term capital gain is the gain itself -- it is always a positive outcome to generate a profit on one of your investments. The tax rules on capital gains are also set up to provide tax advantages for gains on investments held for the long term compared to short-term buying and selling.
Long- vs. Short-Term Gains
Internal Revenue Service rules state that if you own an investment for one year or less, the resulting gain is a short-term capital gain. Holding an investment for longer than one year turns the gain into a long-term capital gain. Long-term gains can result from owning the investment from as little as 366 days to many years. Short-term gains are taxed at your regular, marginal income tax rate, while long-term gains qualify for a lower tax rate.
Long-Term Tax Rate
With the passage of the American Taxpayer Relief Act of 2012, you could pay one of three possible long-term capital gains tax rates. If your income puts you in any tax bracket below the 25 percent bracket, you pay zero capital gains taxes. Taxpayers in the 25 percent bracket up to the next-to-the-top bracket have a 15 percent capital gains tax rate. Investors in the highest tax bracket -- starting at $400,000 in adjusted gross income for single people and $450,000 for married couples -- pay 20 percent long-term capital gains taxes. These top-bracket taxpayers pay 39.6 percent on regular income.
Timing Your Gains
A capital gain does not become a taxable event until you sell the investment and "realize" the gain. You control when an investment is sold and for what year you will pay the capital gains taxes. If your normal income would cause you to pay the highest capital gains tax rate, a year where you income has dropped off may be a good year to sell investments and pay taxes at a lower rate. You can also use capital losses to offset gains, so planning when to sell loser investments may affect when you sell your long-term gainers.
If you pass appreciated investments such as stocks to your heirs when you die, the heirs get a step-up in cost basis, wiping out your long-term gains for tax purposes. Consider a stock you purchased for $5,000 that is worth $100,000 when you pass away. The cost basis for your heir will be the $100,000, and she would pay taxes on any gains above that value. The $95,000 gain you earned on the stock avoids the capital gains tax.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.