Capital gains are generally taxed as ordinary income by the IRS, although the tax rate on capital gains can be lower than the tax rate on ordinary income, depending on the circumstances and the jurisdiction. The holding time of a capital asset affects the tax rate applied to any capital gains realized from its sale. As a general rule, the longer the holding period, the lower the tax rate on the capital gains.
Long-term capital gains from the sale of assets held for more than one year are taxed at a lower rate than short-term capital gains from the sale of assets held for one year or less. This incentivizes long-term investing and discourages short-term speculation. Additionally, the holding time can impact other aspects of tax calculations, such as the cost basis of an asset and the calculation of depreciation.
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Long-term capital gains: Long-term capital gains are gains from the sale of an asset that was held for more than one year. Long-term capital gains are typically taxed at a lower rate than short-term capital gains. The tax rate for long-term capital gains can be 0%, 15%, or 20% on most assets.
Short-term capital gains: Short-term capital gains are gains from the sale of an asset that was held for one year or less. Short-term capital gains are taxed at the same rate as ordinary income, which is typically a higher rate than the tax rate for long-term capital gains. The tax rate for short-term capital gains can be 10%, 12%, 22%, 24%, 32%, 35% or 37%.
2022 long-term capital gains tax rates
| Filing status | 0% tax rate | 15% tax rate | 20% tax rate |
|---|---|---|---|
| Single | $0 to $41,675 | $41,676 to $459,750 | $459,751 or more |
| Married, filing jointly | $0 to $83,350 | $83,351 to $517,200 | $517,201 or more |
| Married, filing separately | $0 to $41,675 | $41,676 to $258,600 | $258,601 or more |
| Head of household | $0 to $55,800 | $55,801 to $488,500 | $488,501 or more |
Short-term capital gains are taxed at the same rate as ordinary income, and depends on your income and filing status. You can view income tax rates for 2022 here.
2023 long-term capital gains tax rates
| Filing status | 0% tax rate | 15% tax rate | 20% tax rate |
|---|---|---|---|
| Single | $0 to $44,625 | $44,626 to $492,300 | $492,301 or more |
| Married, filing jointly | $0 to $89,250 | $89,251 to $553,850 | $553,851 or more |
| Married, filing separately | $0 to $44,625 | $44,626 to $276,900 | $276,901 or more |
| Head of household | $0 to $59,750 | $59,751 to $523,050 | $523,051 or more |
Short-term capital gains are taxed at the same rate as ordinary income. You can view income tax rates for 2023 here.
What are capital gains?
Capital gains are the profits from a sale of a capital asset. When you sell the asset for more than what you paid for it, the difference between the selling price and the cost basis is considered a capital gain. A capital asset is any investment that you own, like stocks, bonds, real estate, vehicles, collectibles, and even cryptocurrencies and NFTs.
How do capital gains work?
Capital gains can either be considered as short-term or long-term.
- Short-term capital gains are gains realized after holding them for less than one year.
- Long-term capital gains are gains realized after holding them for more than one year.
The clock starts when you purchase the asset and ends when you sell it. You must report the capital gain on your annual tax return.
How capital gains are taxed
Short-term capital gains are taxed as ordinary income, and depend on your tax bracket and filing status. For example, if you’re a high income earner and are in the top tax bracket for the year, you can owe up to 37% on your short-term capital gains.
Ordinary income tax brackets: 10%, 12%, 22%, 24%, 32%, 35% or 37%.
Long-term capital gains are taxed at a lower rate than short-term capital gains. Rather than being taxed as ordinary income, it gets taxed according to the capital gains tax rates. These tax rates still count your income, but rates are lower.
Long-term capital gains tax brackets: 0%, 15%, or 20%.
Realized vs unrealized capital gains
Realized capital gains are when you sell the asset for a profit. This triggers a taxable event since you must report any capital gains on your annual tax return.
Unrealized capital gains are gains on assets that you haven’t sold yet. These are not taxable events since you are still holding the asset and haven’t realized your gains.
When do you owe capital gains tax?
All capital gains must be reported on your annual tax filing. You owe the capital gains tax when you realize the gain from the sale of an asset
Example of a capital gain
Let’s say that you decide to purchase 10 shares of Apple (APPL) in February of 2023. For simplicity, we’ll round the stock price to $150 USD, allowing you to purchase 10 shares for $1,500. In June, you decide to sell your shares for $2,500, giving you a $1,000 profit. Because you held your shares for less than one year, this would be considered a realized short-term capital gain of $1,000 and the gain would get taxed as ordinary income. If you make a high income, taxes on your gain could be as high as 37% if you’re in the highest tax bracket.
Now let’s pretend that you held your shares until June, 2024 and profits are the same. Because you held your shares for over a year, it would be considered as a long-term capital gain. Instead of being taxed as ordinary income, it will be subject to capital gains tax rates. Even if you’re in the highest income tax bracket individually, the highest tax bracket for long-term capital gains is 20%.
Capital gains tax rates for retirement accounts
The advantage of a retirement account is that capital gains are deferred until you start taking qualified distributions in retirement (starting at the age of 59½). That means that all earnings from your investments can compound tax-free.
There are two types of retirement accounts that you can invest through: Traditional (pre-tax) and Roth (post-tax).
- With a traditional retirement account (like a 401k or IRA), all profits made from investments in your accounts are tax-deferred until you start taking distributions in retirement. When you withdraw, it gets taxed as regular income regardless of how long you held it. This is because contributions to the account were made with pre-tax income.
- With a Roth retirement account (like a Roth 401k or Roth IRA), you make contributions with post-tax income. Profits in your account compound tax-free, but because you already paid taxes on your contribution, withdrawals in retirement are also completely tax-free. In other words, with a Roth retirement account, you’re not deferring your capital gains tax; you don’t owe any capital gains tax at all, ever.
While withdrawals from Roth retirement accounts are tax-free, withdrawals from traditional pre-tax retirement accounts are always taxed as ordinary income, even if you’ve held the assets for over a year.
How to minimize your capital gains taxes
Here are some tips to reduce your capital gains tax:
- Hold assets for more than a year before selling. This can result in paying a lower capital gains tax.
- Invest in tax-free or tax-deferred accounts like 401(k) plans, Roth IRA accounts, and 529 college savings plans. This way, your investments can grow without being taxed right away, and in some cases, you may not have to pay taxes on the money when you take it out.
- Don’t sell your home too quickly. If you’ve lived in your home as your main residence for at least 2 of the past 5 years, you may be able to exclude up to $250,000 or $500,000 of capital gains when you sell it. Just keep in mind, you can’t take the full exclusion if you sell multiple homes within 2 years.
Also read: Important Tax Filing Deadlines To Remember