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
How do capital gains taxes work? Capital gains can be subject to either short-term tax rates or long-term tax rates. Short-term capital gains are taxed according to ordinary income tax brackets, which range from 10% to 37%. Long-term capital gains are taxed at 0%, 15%, or 20%.
How much tax will I pay on capital gains? ›
Short-term capital gains taxes are paid at the same rate as you'd pay on your ordinary income, such as wages from a job. Long-term capital gains tax is a tax applied to assets held for more than a year. The long-term capital gains tax rates are 0 percent, 15 percent and 20 percent, depending on your income.
How do I avoid capital gains tax? ›
Use tax-advantaged accounts
Retirement accounts such as 401(k) plans, and individual retirement accounts offer tax-deferred investment. You don't pay income or capital gains taxes at all on the assets in the account. You'll just pay income taxes when you withdraw money from the account.
How to calculate capital gain tax? ›
To calculate capital gains, subtract the cost of acquisition and sale expenditures from the sale price. If capital gains exceed Rs. 1 lakh in a fiscal year, apply a 10% tax rate (plus surcharge and cess) on the excess profits. There is no tax duty on gains that are less than Rs. 1 lakh.
What is the 6 year rule for capital gains tax? ›
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
At what age do you not pay capital gains? ›
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
Do I have to pay capital gains tax immediately? ›
It is generally paid when your taxes are filed for the given tax year, not immediately upon selling an asset. Working with a financial advisor can help optimize your investment portfolio to minimize capital gains tax.
Can I reinvest my capital gains to avoid taxes? ›
You can't avoid capital taxes by reinvesting in real estate. You can, however, defer your capital gains taxes by investing in similar real estate property.
How do I calculate capital gains on sale of property? ›
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. Special rates apply for long-term capital gains on assets owned for over a year.
How to reduce capital gains tax on sale of property? ›
You can avoid capital gains tax when you sell your primary residence by buying another house and using the 121 home sale exclusion. In addition, the 1031 like-kind exchange allows investors to defer taxes when they reinvest the proceeds from the sale of an investment property into another investment property.
Capital gains are taxable at both the federal level and the state level. At the federal level, capital gains are taxed at a lower rate than personal income.
What is the capital gains tax for people over 65? ›
The capital gains tax over 65 is a tax that applies to taxable capital gains realized by individuals over the age of 65. The tax rate starts at 0% for long-term capital gains on assets held for more than one year and 15% for short-term capital gains on assets held for less than one year.
What is capital gains tax in simple terms? ›
A capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. These taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment.
What is a simple trick for avoiding capital gains tax on real estate investments? ›
Use a 1031 Exchange
A 1031 exchange, a like-kind exchange, is an IRS program that allows you to defer capital gains tax on real estate. This type of exchange involves trading one property for another and postponing the payment of any taxes until the new property is sold.
Do you have to wait 2 years to avoid capital gains? ›
The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify. The seller must not have sold a home in the last two years and claimed the capital gains tax exclusion.
Do I pay taxes to the IRS when I sell my house? ›
Taxpayers who don't qualify to exclude all of the taxable gain from their income must report the gain from the sale of their home when they file their tax return. Anyone who chooses not to claim the exclusion must report the taxable gain on their tax return.
Is there a way to avoid capital gains tax on the selling of a house? ›
Yes. Home sales can be tax free as long as the condition of the sale meets certain criteria: The seller must have owned the home and used it as their principal residence for two out of the last five years (up to the date of closing). The two years do not have to be consecutive to qualify.
Do capital gains affect the 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.
