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Money Basics: Understanding capital gains

Welcome to Money Basics, Yahoo Finance’s new personal finance series offering quick explanations for some of the most important terms involving your money.

Simply put, a capital gain is profit earned through the sale of an asset, most commonly shares of stock. For example, the profit on a stock that was bought at a low price and sold at a higher price is a capital gain.

Taxes on capital gains are only triggered when the gain becomes realized. For example, if you bought shares of a stock that later went up in value, you would have what’s known as an unrealized gain. Once you sold those shares for a profit, you would have a realized capital gain that is taxable.

Taxes on capital gain are either long-term or short-term gains. Long-term applies to an investment held for 12 months or more after the purchase date. Short-term refers to selling an investment prior to 12 months from the purchase date.

The tax rate on a net capital gain usually depends on your income.

In some tax brackets, a long-term capital gain is taxed at a significantly lower rate than ordinary income. In 2017, capital gains taxes on long-term holdings were as low as 0% for certain brackets and capped out at 20% for the highest income earners. Short-term capital gains do not qualify for a special tax rate and are taxed at the same rate as ordinary income.

The flip side to a capital gain is a capital loss. A capital loss is money lost on an investment. Despite a loss, it can actually be beneficial to investors. Capital losses can be written off and used to offset taxes from capital gains. As with capital gains, capital losses only become tax beneficial when the asset is sold and the loss becomes realized.

As with any tax-related issue, it’s best to check with an accountant to learn more about how capital gains and losses may affect your taxes. Understanding how capital gains and losses work and how to utilize both in tax-advantageous ways are great steps toward taking control of your finances.

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