Capital gains--the difference between what you sell a stock for versus what you paid for it--are "tax preferred," or taxed at lower rates than ordinary income. Ordinary income includes items such as wages and interest income.
Capital gains arise when you sell a capital asset, such as a stock, for more than its purchase price, or basis. Capital gains are further subdivided into short term and long term. If a stock is sold within one year of purchase, the gain is short term and is taxed at the higher ordinary income rate. On the other hand, if you hold the stock for more than a year before selling, the gain is long term and is taxed at the lower capital gains rate.
Conversely, you realize a capital loss when you sell the asset for less than its basis. While it's never fun to lose money, you can reduce your tax bill by using capital losses to offset capital gains. Also, to the extent that capital losses exceed capital gains, you can deduct the losses against your other income up to an annual limit of $3,000. Any additional loss above the $3,000 threshold is carried over to the be used in subsequent years. (Note that due to the IRS' wash-sale rule, you cannot claim a loss if you purchase substantially identical securities 30 days before or after the sale.)
Jobs & Growth Tax Relief Reconciliation Act of 2003 >>