Definition: The profit you make when you sell an investment you’ve owned longer than a year for more than you paid for it. The income tax rate the U.S. government applies to this profit is less than the normal rate. Therefore, the government is giving investors an incentive to hold their investments at least one year.Example: Jill purchases 100 shares of DEF Corporation for $20 per share on January 1. On January 15 of the following year she sells all 100 shares for $25 per share. The $500 (100 shares * $5 per share) profit is considered a long-term capital gain. She will pay less federal income tax on this profit than she will on $500 she earns at her job.
Investeach explains: While one year can hardly be considered long-term, the government’s idea is to get people to think about truly becoming investors and not traders who constantly buy and sell. If more investors thought this way, our stock markets would experience fewer scary up and down swings.
Riddle me this:
1. How long must a person hold a profitable investment before it is considered a long-term gain?
2. How is the tax rate applied to the profit lower than the normal rate?
3. Why would the government offer this benefit to investors?