It is a fact of life that active traders and investors generate capital gains and losses - lots of them! The very nature of trading calls for buying and selling the same stocks and / or options over and over again.
When you trade or invest in equities such as stocks, options, bonds, mutual funds, and other capital assets, you may owe a capital gains tax on the profits from the sale of those investments.
In a nutshell, the capital gain from the sale of an investment is calculated by subtracting your basis in the asset you sold, from the amount you realized in the sale. Your basis is your cost or the purchase price plus brokerage commissions and SEC fees. The amount realized is what you received from the sale, less brokerage commissions.
Traders and investors also receive ordinary income, which includes dividends and interest. Ordinary income is not considered a capital gain, therefore dividends and interest are not part of your capital gain calculation.
Active traders benefit from generating capital gains instead of ordinary income for two reasons:
As each type of capital gain has a different tax treatment, successful traders often select their investments and time their trades to produce specific tax results. TradeLog™ offers the active trader an automated way to log all their executed trades and run quick, concise reports that allow them to keep a handle on their capital gains and losses throughout the year.
Let’s take a closer look the IRS capital gains tax treatment for both types.
If the date of the sale is one year or less after the date of the purchase, you have a short-term capital gain.
Example:
You bought 100 shares of ABC on May 12, 2004.
You sold the same 100 shares of ABC on May 18, 2004.
This sale results in a Short-Term gain as the holding period was less than 366 days.
Short-term capital gains are taxed at the same rate as ordinary income (like wages and interest income), unless you have a capital loss that offsets it. If you are in the highest federal tax bracket and you pay state capital gains tax, it's possible to owe more than 40% of your investment gain in short-term capital gains taxes.
If the date of the sale is more than one year (366 days or more) after the date of the purchase, you have a long-term capital gain.
Example:
You bought 100 shares of ABC on May 12, 2003.
You sold the same 100 shares of ABC on May 18, 2004.
This sale results in a Long-Term gain as the holding period was more than 365 days.
The gain realized from selling a long-term holding is taxed at a lower rate than short-term gains. Long-term capital gains are taxed at 15% for all tax brackets other than 10% and 15% which pay an even lower long-term rate of 5%.
Therefore, when figuring your taxes for the year, each gain or loss must be classified as either short-term or long-term.
Sadly, none of the trades listed on your broker provided 1099 will be identified as short- or long-term. That means it is up to you to do this manually, perhaps for hundreds of trades. Who has that kind of time?
TradeLog™ allows you to import an entire year's worth of trades in minutes and run a simple, "IRS ready" short-term and long-term Gains and Losses report.