A capital gain is realized when a capital asset is sold or exchanged at a price higher than its basis. Basis is an asset’s purchase price, plus commissions and the cost of improvements less depreciation. A capital loss occurs when an asset is sold for less than its basis. Gains and losses (like other forms of capital income and expense) are not adjusted for inflation.
Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Short-term capital gains are taxed as ordinary income at rates up to 37 percent; long-term gains are taxed at lower rates, up to 20 percent. Taxpayers with modified adjusted gross income above certain amounts are subject to an additional 3.8 percent net investment income tax (NIIT) on long- and short-term capital gains.
The Tax Cuts and Jobs Act (TCJA), enacted at the end of 2017, retained the preferential tax rates on long-term capital gains and the 3.8 percent NIIT. TCJA separated the tax rate thresholds for capital gains from the tax brackets for ordinary income for taxpayers with higher incomes (table 1). The thresholds for the new capital gains tax brackets are indexed for inflation, but, as under prior law, the income thresholds for the NIIT are not. TCJA also eliminated the phaseout of itemized deductions, which had raised the maximum capital gains tax rate above the 23.8 percent statutory rate in some cases.
There are special rules for certain types of capital gains. Gains on art and collectibles are taxed at ordinary income tax rates up to a maximum rate of 28 percent. Up to $250,000 ($500,000 for married couples) of capital gains from the sale of principal residences is tax-free if taxpayers meet certain conditions, including having lived in the house for at least 2 of the previous 5 years. Up to the greater of $10 million of capital gains or 10 times the basis on stock held for more than five years in a qualified domestic C corporation with gross assets under $50 million on the date of the stock’s issuance are excluded from taxation. Also excluded from taxation are capital gains from investments held for at least 10 years in designated Opportunity Funds. Gains on Opportunity Fund investments held between 5 and 10 years are eligible for a partial exclusion.
Capital losses may be used to offset capital gains plus up to $3,000 of other taxable income. The unused portion of a capital loss may be carried over to future years.
The tax basis for an asset received as a gift equals the donor’s basis. However, the basis of an inherited asset is “stepped up” to the value of the asset on the date of the donor’s death. The step-up provision effectively exempts from income tax any gains on assets held until death.
C corporations pay the regular corporation tax rates on the full amount of their capital gains and may use capital losses only to offset capital gains, not other kinds of income.
Maximum Tax Rate on Capital Gains
For most of the history of the income tax, long-term capital gains have been taxed at lower rates than ordinary income (figure 1). The maximum long-term capital gains and ordinary income tax rates were equal in 1988 through 1990. Since 2003, qualified dividends have also been taxed at the lower rates applied to long-term capital gains.
Updated January 2024
Further Reading
Auten, Gerald. 2005. “Capital Gains Taxation.” In Encyclopedia of Taxation and Tax Policy, 2nd ed., edited by Joseph Cordes, Robert Ebel, and Jane Gravelle, 46–49. Washington, DC: Urban Institute Press.
Burman, Leonard E. 1999. The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed. Washington, DC: Brookings Institution Press.
Gleckman, Howard. 2022. “Expanding the Net Investment Tax Mostly Would Target Households Making $1 Million or More.” TaxVox (blog). Washington, DC: Urban-Brookings Tax Policy Center.
Gleckman, Howard. 2022. “The Many Ways to Tax the Rich.” Washington, DC: Urban-Brookings Tax Policy Center.
Kobes, Deborah, and Leonard E. Burman. 2004. “Preferential Capital Gains Tax Rates.” Tax Notes. January 19.
FAQs
At the federal level, capital gains are taxed based on the several factors including the type of asset, how long you held the asset, and your overall income level. If you only held the investment for a year or less, then the short-term capital gains tax rates will apply.
What is a capital gains tax quizlet? ›
The idea behind Capital Gains Tax ('CGT') is to tax the profit that a person might make from disposing of a capital asset which has appreciated (increased) in value during their period of ownership. CGT is charged where there is: - a Chargeable Disposal. - of a Chargeable Asset.
Why does capital gains tax exist? ›
The capital gains tax raises money for government but penalizes investment (by reducing the final rate of return). Proposals to change the tax rate from the current rate are accompanied by predictions on how it will affect both results.
Why capital gains should not be taxed? ›
Taxing capital gains effectively increases the cost of funds to firms because it reduces the after-tax return to stockholders. In other words, if potential stockholders knew that they would not have to pay taxes on the appreciation of their assets, they would be willing to pay a higher price for new issues of stock.
How are capital gains taxed vs income? ›
Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Short-term capital gains are taxed as ordinary income at rates up to 37 percent; long-term gains are taxed at lower rates, up to 20 percent.
How do you avoid capital gains tax? ›
Here are four of the key strategies.
- Hold onto taxable assets for the long term. ...
- Make investments within tax-deferred retirement plans. ...
- Utilize tax-loss harvesting. ...
- Donate appreciated investments to charity.
Capital gains refers to profits gained from the sale of capital assets. Almost everything someone owns and uses for personal or investment purposes is a capital asset.
What is capital gains simplified? ›
A capital gain is the increase in a capital asset's value and is realized when the asset is sold. Capital gains may apply to any type of asset, including investments and those purchased for personal use. The gain may be short-term (one year or less) or long-term (more than one year) and must be claimed on income taxes.
Which phrase best describes a capital gain? ›
A capital gain is realized when a customer sells a security at a higher price than its original cost. The phrase “buy low, sell high” refers to capital gains.
Is capital gains tax good or bad? ›
Long-term capital gains tax rates are often lower than ordinary income tax rates. Capital gains are taxed at rates of zero, 15 and 20 percent, depending on the investor's total taxable income. That compares to the highest ordinary tax rate of 37 percent for 2024. The capital gains tax rates are highly advantageous.
Cons. A big negative of capital gains taxes is that they cut into your return on investment. You may have just sold a stock for a 20% gain, but, after state and federal taxes, your gain may be significantly lower.
Do capital gains get taxed twice? ›
The taxation of capital gains places a double tax on corporate income. Before shareholders face taxes, the business first faces the corporate income tax.
How is capital gains tax calculated on sale of property? ›
Broadly speaking, capital gains tax is the tax owed on the profit (aka, the capital gain) you make when you sell an investment or asset. It is calculated by subtracting the asset's original cost or purchase price (the “tax basis”), plus any expenses incurred, from the final sale price.
How much capital gains are tax free? ›
Capital gains tax rates
A capital gains rate of 0% applies if your taxable income is less than or equal to: $44,625 for single and married filing separately; $89,250 for married filing jointly and qualifying surviving spouse; and. $59,750 for head of household.
Are capital gains added to your total income and put you in a higher tax bracket? ›
Long-term capital gains can't push you into a higher tax bracket, but short-term capital gains can. Understanding how capital gains work could help you avoid unintended tax consequences. If you're seeing significant growth in your investments, you may want to consult a financial advisor.
