How Capital Gains Tax Works Right Now

What capital gains tax is and who pays it

Capital gains tax is a tax on the profit you make when you sell an asset for more than you paid for it. If you buy a stock for $1,000 and sell it for $1,500, that $500 difference is your capital gain, and it is subject to tax. The tax applies to real estate, stocks, bonds, cryptocurrency, art, and most other things of value you own.

You only owe capital gains tax when you actually sell the asset. Holding onto an investment that has grown in value does not trigger a tax bill — the tax happens at the moment of sale. This is why some people hold investments for years without paying tax on the gains.

Not everyone pays capital gains tax. If you sell something for less than you paid for it, you have a capital loss instead, which can reduce your tax burden. If you do not sell investments or property, you do not owe capital gains tax that year, even if their value has climbed.

Key Takeaways

• Capital gains tax is owed on the profit from selling an asset, and the tax rate depends on how long you held it before selling.
• Long-term capital gains (held over one year) are taxed at lower federal rates than short-term gains, which are taxed as ordinary income.
• Your tax bracket, filing status, and total income all affect your capital gains tax rate, and rates vary by state.
• Capital losses can offset capital gains, reducing the amount of gain you owe tax on.
• You report capital gains on your federal tax return, and some states also tax capital gains.

Long-term versus short-term capital gains

The federal government taxes capital gains differently depending on how long you owned the asset. If you held it for more than one year before selling, it is a long-term capital gain. If you held it for one year or less, it is a short-term capital gain.

Short-term capital gains are taxed as ordinary income, meaning they are taxed at the same rate as your wages or salary. Long-term capital gains receive preferential treatment and are taxed at lower federal rates: 0%, 15%, or 20%, depending on your income and filing status. Because of this difference, many investors try to hold assets for longer than one year to may have access to for the lower long-term rate.

The one-year holding period is measured from the date you bought the asset to the date you sold it. If you bought stock on March 15, 2023, and sold it on March 14, 2024, it counts as short-term because you did not hold it for a full year.

Federal tax rates for long-term capital gains

Long-term capital gains are taxed at 0%, 15%, or 20% at the federal level. Which rate you pay depends on your taxable income and your filing status (single, married filing jointly, head of household, or married filing separately).

The income thresholds that determine your rate change each year. For example, in 2024, a single filer with taxable income below a certain amount pays 0%, income in a middle range pays 15%, and income above that pays 20%. A married couple filing jointly has higher income thresholds before moving into the 15% and 20% brackets.

Your total taxable income — including wages, interest, dividends, and capital gains — determines which bracket you fall into. If you have a large capital gain in a year when your other income is high, you may end up in a higher capital gains tax bracket than you would in a year with lower overall income.

State capital gains taxes

Most states do not have a separate capital gains tax. However, some states tax capital gains as ordinary income, meaning your long-term gains are taxed at your state income tax rate. A few states have enacted their own capital gains taxes that explore only to certain high-income sales or explore a flat rate.

State tax rates and rules vary widely. Some states tax all capital gains the same way they tax wages. Others have recently passed laws that tax only gains above a certain dollar amount or only gains from the sale of certain assets. A few states have no income tax at all, so residents pay no state capital gains tax.

You will owe both federal and state capital gains tax if your state taxes capital gains. Your state tax bill is separate from your federal bill and is calculated according to your state's rules.

How to report capital gains on your tax return

You report capital gains on your federal tax return using Schedule D (Form 1040), which is a form that lists each asset you sold during the year. For each sale, you enter the date you bought it, the date you sold it, your purchase price, your sale price, and your gain or loss.

If you sold only one or two assets and the gains are small, you may be able to report them directly on your main tax form without using Schedule D, depending on the IRS rules that year. Your tax software or tax preparer can tell you which forms you need.

If you have capital losses, you report those on Schedule D as well. Capital losses can offset capital gains, reducing the amount of gain you owe tax on. If your losses exceed your gains in a year, you can use up to $3,000 of the excess loss to reduce your ordinary income, with any remaining loss carried forward to future years.

Using capital losses to reduce your tax bill

A capital loss occurs when you sell an asset for less than you paid for it. These losses can be used to offset capital gains, which lowers the amount of gain you owe tax on. If you sold a stock at a $2,000 gain and another at a $500 loss, you would owe tax on only $1,500 of gain.

If your capital losses exceed your capital gains in a year, you can use the excess to reduce your ordinary income by up to $3,000 per year. Any losses beyond that $3,000 limit carry forward to future years, where they can offset gains or reduce income again.

This strategy, called tax-loss harvesting, is sometimes used by investors who sell losing positions to offset gains from winning positions. However, there are rules about repurchasing the same or substantially identical asset within 30 days (the "wash-sale rule"), which can affect whether the loss counts.

Special situations: inherited assets and home sales

When you inherit an asset, you receive what is called a stepped-up basis. This means your cost basis (the value used to calculate gain or loss) is reset to the asset's value on the date of the person's death, not what they originally paid for it. If someone left you a house they bought for $100,000 that was worth $300,000 when they died, your basis is $300,000. If you sell it shortly after for $305,000, you owe tax on only $5,000 of gain.

Home sales have their own rule. If you are single and sell a home you lived in for at least two of the last five years, you can exclude up to $250,000 of gain from tax. If you are married filing jointly, you can exclude up to $500,000. This exclusion applies once every two years.

Frequently Asked Questions

Do I owe capital gains tax if I do not sell the investment?

No. Capital gains tax is only owed when you sell an asset. If you own stock, real estate, or cryptocurrency that has increased in value but you have not sold it, you do not owe tax on that gain. The tax is triggered by the sale itself.

What is the difference between capital gains and dividends?

Capital gains are profits from selling an asset. Dividends are payments a company makes to shareholders from its earnings, usually paid while you still own the stock. Dividends can be taxed as ordinary income or as may have access to dividends at capital gains rates, depending on how long you held the stock and the type of dividend.

Can I deduct investment losses from my taxes?

Yes, but with limits. Capital losses offset capital gains first. If losses exceed gains, you can deduct up to $3,000 of the excess against ordinary income in that year. Any remaining losses carry forward to future years. You cannot deduct losses from personal-use property like your home or car.

Do I have to pay capital gains tax the year I sell, or can I pay it later?

You report capital gains on your tax return for the year you sold the asset, and you owe the tax by the tax filing important date (usually April 15). You do not get to defer the tax to a later year unless you use a special strategy like a like-kind exchange or installment sale, which have specific rules.

What happens if I sell an asset at a loss?

You have a capital loss, which you report on Schedule D. The loss reduces any capital gains you had that year. If losses exceed gains, you can use up to $3,000 to reduce your ordinary income. Any loss beyond that carries forward to offset gains or income in future years.