This is the third post a series of Tax Relief advice articles, be sure to read the first one about Deducting State Sales Tax Instead of State Income Tax and the second one about the Alternative Minimum Tax. You can see the whole collection under the category of Tax Relief 101 .

If you invest in anything whatsoever, capital gains and losses are a necessary and often misunderstood aspect of your taxes. What differentiates a long term capital gain and a short term capital gain? If I miss on an investment, how can that pain be lessened by gains youve had in other investments? Whats this Ive heard about dividends being taxed at a lower rate? Get your pens and pencils and read on.

Long Term vs. Short Term Gains

If youve owned the investment for over 366 days (1 year plus 1 day), then it is taxed as a long term capital gain. If youve owned it for less than a year, its taxed as a short term capital gain. Its as simple as that.

Recently, the long term capital gains tax rate was lowered by 5% for every tax bracket (effective until 2008). Now, the rates are 5, 15, 25, and 28%. If your income is taxed in the 10-15%, your maximum long term capital gain tax is 5%. Everyone else is taxed at the 15%. The 25% rate applies to real estate youve sold that you claimed any depreciation on (Section 1250 property). The final 28% category is for small business stock and collectibles.

Short term capital gains? Theyre taxed as income for the year! If youre in the 15% tax bracket, itll be taxed at 15% (instead of at 5%). Thats why they say that short term capital gains can eat into your stock profits because of the significantly higher (10% difference) tax rate.

Capital Losses Offsetting Capital Gains

If you make a bad pick (or two or twenty), any losses you sustain can be used to offset any gains you had this year. If you had a particularly bad year and had no gains, up to $3,000 of the losses can be used to offset your other income. If youve lost more than $3,000, then you can carry it to the following year. Thats why you hear advice from professionals about selling stocks in which youre in the red in order to offset the gains youve had. One important rule you must understand is the Wash Rule which only allows this offset if you do not repurchase the stock within 30 days, otherwise this is thrown out.

Dividends Taxed at 5, 15%

Remember the two tax brackets for gains? Well now dividends are taxed at those rates, 5% for 10-15% taxpayers and 15% for everyone else.

I hope Ive covered a few of the big concepts of capital gains taxes that give people the most trouble and dispelled some of the misconceptions people carry around. I wouldnt let capital gains taxes dictate your investment strategy but its a very important aspect to always keep in mind.