What is it:
A long-term capital gain is the profit from selling an asset, such as company stock, that you held for more than one year. Long-term capital gains are taxed at preferential federal rates of 0%, 15%, or 20%, depending on your taxable income. These rates are well below the top rates on ordinary income. Gains on assets held for one year or less are short-term capital gains, taxed as ordinary income.
Why does it matter:
Whatever the equity instrument, the holding period decides whether your gain gets the lower rate. Sell within a year of acquiring the shares, and any gain is taxed as ordinary income; hold for more than a year, and it can qualify for long-term rates. For most equity, only the growth after you acquire the shares can qualify, since the value at vesting or exercise is taxed as ordinary income at that point. Holding longer is a tradeoff: a potentially lower tax rate in exchange for keeping more of your wealth in a single company’s stock.
What do people most often get wrong:
People often start counting the holding period from the grant date. The clock doesn't start until you own the shares, so options granted years ago that you exercise and sell on the same day produce no long-term gain at all. The threshold is also more than one year, not one year: shares sold exactly one year after you acquired them still produce a short-term gain.