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IT WOULD JUST be too much to ask, wouldn't it? You buy a stock, watch it grow, cash out and count your profits. Unfortunately, Uncle Sam is looking over your shoulder, counting right along with you. Unless the stock is held in a retirement account (which can be tax-deferred or even tax-free) you've got to pay the piper on any investment gain you make. It's called the capital-gains tax, and it isn't pretty.
At the moment, the maximum federal-tax rate on long-term capital gains - from stocks, mutual funds, bonds and most other investment assets - is 20%. (Starting in tax year 2006, investments that have been held for more than five years will be taxed at 18%.) By "long term," the IRS means you've held the asset for more than 12 months. If you've held it for less than that by the time you sell, it's called a short-term capital gain. Those are taxed at your regular income-tax rate - which can be as high as 38.6%.
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| Calculations assume you pay 27% in taxes on your profits, if you sell every year. |
There are some exceptions to these rules, but most of the time, that's what you're faced with. By now, you're probably drawing the obvious conclusion: It's better to buy securities and hold on to them for at least 12 months. If you "churn" your account by buying and selling machine-gun style, the government will penalize you.
In fact, if you play with the above applet, you'll see that it's best to hold your securities for as long as you can. Even if you wait 12 months and then sell, the 20% bite is a big one. Say you're in the 27% tax bracket and you make 10% a year for 30 years on an investment of $1,000. If you buy and hold, you end up with about $14,200 after taxes. But if you sell your stocks and buy new ones each year, paying 27% taxes on your profits along the way, your end total is about $8,300. The longer you hold, the more you make.
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Unless your investments are held in a tax-deferred retirement account, you've got to pay the piper on any profit you make. It's called the capital-gains tax, and it isn't pretty.
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