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.
What is capital gains simplified? ›
Put simply, a capital gain occurs when you sell an asset for more than what you originally paid for it. Almost any type of asset you own is a capital asset. This can include a type of investment (like a stock, bond, or real estate) or something purchased for personal use (like furniture or a boat).
What is the loophole for capital gains tax? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
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 capital gains work when selling a house? ›
If you sell a house or property in one year or less after owning it, the short-term capital gains is taxed as ordinary income, which could be as high as 37 percent. Long-term capital gains for properties you owned for over a year are taxed at 0 percent, 15 percent or 20 percent depending on your income tax bracket.
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.
Which is an example of capital gains tax quizlet? ›
For example, a mutual fund sells the stock of XYZ Company which it held for more than one year and had a gain. That gain is proportionately reported to the shareholders as a capital gain on Form 1099-DIV.
Why capital gains should not be taxed? ›
Economic theory tells us that when the cost of funds goes down, firms will use the opportunity to borrow more funds so that they can increase their investment in new property and equipment. Taxing capital gains effectively increases the cost of funds to firms because it reduces the after-tax return to stockholders.
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.
This means that if you sell your home for a gain of less than $250,000 (or $500,000 if married, filing jointly), you will not be obligated to pay capital gains tax on that amount.
What capital gains are exempt? ›
Key Takeaways
You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.
How much capital gains is not taxable? ›
For example, in 2023, individual filers won't pay any capital gains tax if their total taxable income is $44,625 or below. However, they'll pay 15 percent on capital gains if their income is $44,626 to $492,300. Above that income level, the rate jumps to 20 percent.
What is the capital gains tax on $1 million dollars? ›
If the $1 million is from a long-term capital gain, such as the sale of stocks or real estate, you'll pay a lower tax rate than if it were ordinary income. The long-term capital gains tax rate is currently 20% for high-income earners. Capital gains and other investment income are also free of FICA tax.
At what age do you not pay capital gains? ›
Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the “tax basis.”
