What is the difference between short-term and long-term capital gains?

The correct distinction between short-term and long-term capital gains is that short-term gains arise from the sale of assets held for one year or less, whereas long-term gains come from assets held for more than one year. This definition is critical because it determines how different types of capital gains are taxed. Short-term capital gains are taxed as ordinary income, which can be at higher rates depending on the taxpayer's overall income level. In contrast, long-term capital gains usually benefit from lower tax rates, reflecting the federal government's encouragement of long-term investment strategies.

Understanding this difference is essential for taxpayers planning their investment strategies and tax liabilities, as it can significantly impact their overall tax burden based on how long they hold an asset before selling it.