Money Smarts

Chapter 8 Money Smarts: Capital Gains

A capital gain is the profit from the sale of an asset such as stocks or bonds. Suppose you buy 100 shares of stock for $10 per share. What if the price goes up to $12 per share and you sell the stock? Congratulations! You made a profit of $200 ($1,200 – $1,000). But if the price goes down to $8 per share and you sell the stock, you will have a capital loss of $200 ($800 – $1,000). A capital loss is the sale of an investment for less than its purchase price.

How are capital gains taxed? It depends on whether they are short-term or long-term. A short-term capital gain is one made when you sell an asset that you have owned for 12 months or less. It is taxed as ordinary income. A long-term capital gain is the gain on the sale of an investment held for more than 12 months. Long-term capital gains are taxed at 15 percent for most people.

The exercise on this calculator assumes that you will have capital gains, not capital losses. The projections used in this exercise are just that — projections — and may not come close to future market behavior.

Go to the BusinessWeek Online Personal Finance Investing calculators. Under Stock Calculators, click on “Should I wait a year to sell my stock?”

Input the following values:

Click on the “get your results” button and answer the following questions.

1. If this is a short-term capital gain, how much tax will you pay? What is the rate of return?
2. If this is a long-term capital gain, how much tax will you pay? What is the rate of return?
3. Which has the better rate of return: the short-term investment or the long-term investment? Why?
4. Click on the INPUTS tab and change your federal tax rate to 35 percent. What is the rate of return on the short-term investment? Is it different from your answer to Question 1? Why or why not?
5. What is the rate of return on the long-term investment? Is it different from your answer to Question 2? Why or why not?