What Are Capital Gains Taxes? (2024)

You must pay taxes on most types of income, and that includes money you earn from selling investments. Capital gains are profits from the sale of various types of investments, including stocks, bonds, real estate and collectibles—and these profits are subject to capital-gains taxes.

How the Internal Revenue Service treats the gains will depend on your filing status, taxable income and, most important, how long you owned the asset.

You’re only taxed when you sell an investment, and you can generally choose when you do so, which is why it’s helpful to be aware of the capital-gains tax rules, says Rob Williams, managing director of financial planning at Charles Schwab. “Many investors may not think about that return after-tax and really, that’s what you keep.”

You may have to pay capital-gains taxes for routine trading activity in your brokerage account or a more complex transaction, such as selling your home, which is why it’s important to understand the rules around capital-gains taxes before you act.

What are capital gains?

If you sell an investment for more money than you paid to buy it, then you’ve realized a capital gain. You can generate capital gains from the profitable sale of stocks, bonds, cryptocurrency, real estate, cars, art and other types of assets. You will likely owe taxes on the profit you made from these transactions, though the rate varies depending on a few factors.

Capital gains are split into two groups—short- and long-term—that depend on how long you owned an asset before you sold. Assets held for a year or less are taxed at the same rate as ordinary income, while assets you’ve owned for more than a year are generally taxed at a lower rate.

You must pay federal taxes on any capital gains, but the IRS rewards saving and long-term investments by offering preferential tax treatments for short- versus long-term capital gains, notes JR Gondeck, a Boca Raton, Fla.-based partner at The Lerner Group, a wealth-management firm. “The government doesn’t want to incentivize speculation.”

Short-term capital gains

Short-term capital gains are the profits you make from selling an asset you’ve held for one year or less. The IRS treats short-term capital gains that same as ordinary income, which means the taxrate you’ll pay on short-term profits taken in this year will correspond with your 2024 federal income tax brackets which range from 10% to 37%.

Long-term capital gains

Long-term capital gains, on the other hand, are the profits you make from selling an asset you’ve held for more than one year. There are only three tax rates for long-term capital gains: 0%, 15% and 20%, and the IRS notes that most taxpayers pay no more than 15%. High earners may also be subject to a 3.8% net investment income tax, which could bring the maximum tax rate for long-term capital gains to as much as 23.8%. Qualified dividends are also taxed at the long-term rate.

Given the differences between the short- and long-term capital-gains tax rates, tax planning can save you money, notes Williams. “Before you sell any investment, it’s important to look at your holding period and if you can, if possible—assuming you’re not taking undue risks—wait 365 days to qualify for the long-term capital-gains tax rate.”

How to calculate capital gains

Calculating your capital gains can be fairly straightforward, particularly for stocks. All you need to know is the cost basis, or how much you originally paid for the investment, and the sale price. If you purchased 100 shares of a stock for $20 per share and later sold it for $35 per share, you realized a capital gain of $1,500.

The IRS doesn’t take into account what’s been happening in the economy during the time you’ve held the asset, which means capital gains aren’t adjusted for inflation. As a result, you will owe taxes on the full amount of your capital gains regardless of whether inflation has decreased the value of your money over the holding period.

While the formula for calculating capital gains doesn’t change, your cost basis isn’t always as straightforward as it might seem. Consider a stock split, for example. If a company issues additional shares to shareholders, then the price of each share will adjust—as will your cost basis. Meanwhile, reinvesting dividends means you buy fractional shares at various prices, which creates multiple cost bases.

Luckily, you typically won’t need to calculate your capital gains. That’s because brokers must provide to clients by Feb. 15 of each year a Form 1099-B, which details proceeds from transactions and includes details about capital gains—provided the company has all of the salient information about your cost basis and transactions.

Even with detailed information from your broker, capital-gains taxes can still be tricky to navigate successfully. That’s particularly true if you’re an active trader or if you work with multiple advisors who help manage your capital-gains tax bills with a strategy known as tax-loss harvesting, notes Derek Pszenny, co-founder of Carolina Wealth Management in Pinehurst, N.C. “The more complicated it gets, then the more help you need.”

How are capital gains taxed?

The amount of time you’ve owned an asset determines whether your capital gains are taxed like ordinary income by the IRS—or whether you’ll receive a preferential tax rate. You will pay a lower tax rate for those investments you’ve held for longer than one year. Here are the applicable tax rates for long-term capital gains for 2023—filed in 2024—and 2024 tax years:

Long-term capital-gains rates for 2023

What you’ll pay depends on your 2023 taxable income

Long-term capital-gains rates for 2024

What you pay depends on your 2024 taxable income

Source: IRS

Because the tax implications are higher for short-term gains, it’s important to be mindful of “tax drag,” or the amount of tax you’ll have to pay on the profit if you incur a short-term gain, Williams advises. But don’t focus too much on tax implications at the expense of your risk tolerance and portfolio considerations, he adds. “No one wants to pay tax, but it’s important to consider tax in the context of a comprehensive assessment plan.”

Net investment income tax

As indicated, high earners may be subject to an additional 3.8% surcharge on net investment income. The tax is 3.8% of the lesser amount of either your net investment income or the amount by which your modified adjusted gross income exceeds the following thresholds based on filing status:

• Single or head of household: $200,000
• Married filing jointly: $250,000
• Married filing separately: $125,000
• Qualifying widow(er) with dependent child: $250,000

How do states tax capital gains?

Your capital-gains tax obligations don’t end with the IRS. You may need to pay state taxes on your profits, though the amount you will pay can vary widely state to state. The top marginal capital-gains tax rate (combining the state and federal rate) ranges from 20% to 33% for 2023, depending on where you live.

The states that max out at a 20% capital-gains tax rate are the nine states with no personal income tax—including Florida, Texas, Washington and Tennessee. At the other end of the spectrum are the states with the highest capital tax rates, including California (with a maximum 13.3% state capital-gains tax), New Jersey (10.75%), Oregon (9.9%), Minnesota (9.85%) and New York (8.82%).

How are assets besides stocks taxed

Just as state capital-gains tax rates vary, so do some of the specifics for assets other than stocks. The general concept of capital gains remains the same, but the way other assets are taxed can vary based on some special tax rules that may apply or because of differing rates imposed by the IRS.

Real estate

There are different capital-gains tax rules that apply to the sale of rental property versus your primary residence. After the sale of your primary residence, you may exclude up to $250,000 of the capital gain (or up to $500,000 if you file a joint tax return with your spouse). To qualify for this exclusion, you must have owned and lived in your home as your primary residence for at least two of the five years before the sale date.

Real estate you’ve purchased as an investment is subject to different tax rules—and the same exclusions as a primary residence don’t apply. With rental real estate, you can take yearly tax deductions by depreciating the value of the property over time. When you sell that property, you must pay the IRS a 25% depreciation recapture tax on the portion of your capital gain that you previously claimed as depreciation, along with the applicable short- or long-term capital-gains taxes.

The IRS does allow taxpayers to trade one real-estate investment for another and incur no immediate tax liability, provided that the new property is the same type or “like-kind.” This is called a “1031 exchange.” As a result, real estate can be a “great vehicle” to defer capital-gains taxes, Gondeck says.

Collectibles

Special capital-gains tax rules apply to the profitable sale of collectibles, including art, stamps, coins, NFTs and antiques. The net capital gains are taxed at a maximum rate of 28%, so it’s important to factor in this higher rate when selling items from your collection.

Items not subject to special capital-gains tax treatment

The normal capital-gains tax rules apply to the following types of assets:

• Stocks
• Bonds
• Mutual funds
• Exchange-traded funds (ETFs)
• Commodities
• Cryptocurrency
• Vehicles
• Home furnishings
• Business assets
• Partnerships and limited liability companies (LLCs)

How to avoid capital-gains tax

Investors may not be able to completely avoid the capital-gains tax, but there are very viable ways to reduce or defer this liability.

Tax-loss harvesting

One way to avoid capital-gains taxes is by simply selling investments at a loss. This strategy, known as tax-loss harvesting, allows you to offset your capital gains with capital losses, thereby reducing your tax liability. “There may be some silver lining in a down market to harvest some of those losses by selling,” Williams says.

It’s important to keep track of your holding periods, however, as a long-term loss offsets a long-term gain while a short-term loss offsets a short-term gain, Pszenny advises. If you can overcome the common psychological barrier that many people have about selling an investment at a loss and instead see the tax advantages, it can make the decision easier, he adds. “Nobody likes to take losses, but realized losses help you offset realized gains.”

Realizing a capital loss has additional benefits. That’s because these losses could reduce your taxable ordinary income by up to $3,000 each year, even if you don’t incur any capital gains, and you may be able to carry over more than that amount to subsequent tax years. “That makes loss harvesting a very important part of your portfolio management for your taxable account, and I would probably prefer to harvest as many losses as I can,” Pszenny adds.

Wash sales

If you opt for tax-loss harvesting, it’s important to be aware the IRS has rules about buying a similar asset. After selling an asset, you must wait at least 30 days to avoid a “wash sale” before buying a similar asset so you can take advantage of the perks of tax-loss harvesting.

401(k) and IRA accounts

You won’t pay capital-gains taxes on the profitable sale of investments in your 401(k), IRA or other tax-advantaged accounts such as a health-savings account, or HSA, or a 529 savings plan. Fully funding these types of accounts is a way to avoid capital-gains taxes and people who actively trade may opt to do so in an IRA, for example, rather than a taxable account.

Direct indexing

Direct indexing is a strategy that allows you to mimic the returns of a benchmark, such as the S&P 500, by buying all of the stocks in that index. With this strategy, you can sell the underperforming stocks in that benchmark to capture a loss—and direct indexing can be “very, very powerful” for helping to minimize capital gains, Pszenny says.

Inherited or gifted assets

A final way to avoid the capital-gains tax is by gifting assets. While you avoid the tax, the burden transfers to the recipient who must pay the capital gains at their applicable rate, Gondeck notes.

By instead bequeathing assets upon your death, this may be more favorable for the recipient tax-wise. Thanks to a provision known as the step-up basis, the cost basis of the inherited asset is adjusted to its fair market value on the date of the decedent’s death, rather than when it was originally acquired. That said, special rules apply to inherited IRAs.

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