What is short-term capital gains tax?
A capital gain happens when you sell an asset for more than your cost basis (which is usually the amount you paid for it).
For example, suppose you purchased 100 shares of stock at $10 per share. Later on, you sell those same shares for $15 per share. The difference between your cost basis of $10 per share and your sale of $15 per share is $5 per share, for a total capital gain of $500.
A short-term capital gain specifically happens when you sell an asset that you’ve held for less than one year. For example, if you had sold those 100 shares of stock after just nine months, you would have a short-term capital gain.
Short-term capital gains have a less favorable tax treatment than assets you hold for a longer period. Rather than being taxed at the long-term capital gains tax rate, short-term capital gains are taxed as ordinary income. Depending on your tax bracket, your short-term capital gains tax could be anywhere between 10% and 37%.
What is long-term capital gains tax?
While short-term capital gains are those on an asset you’ve held for less than one year, a long-term capital gain is on an asset you’ve held for more than one year.
In many ways, the rules for short-term and long-term capital gains are similar. In both cases, your capital gain is the difference between your cost basis in the property (usually the amount you bought it for) and the amount you sell it for.
The benefit of holding an asset for longer than one year is that the long-term capital gains tax rates are lower than those for short-term capital gains. Unlike short-term gains, long-term gains aren’t taxed at your ordinary tax rate. Instead, the federal government has special tax rates in place. The amount you’ll pay depends on your annual income but will range from 0% to 20% (certain assets including collectibles and section 1202 qualifying small business stock may be taxed at a rate of up to 28%).
Going back to our previous example, if you had held your 100 shares of stock for 13 months instead of nine, you would have been eligible for the more favorable long-term capital gains tax treatment.
Find out more:Â Short-term vs. long-term capital gains tax
What are the capital gains tax rates?
The tax rate you’ll pay on capital gains depends on whether you had a long-term or short-term gain and your household income for the year.
2022-2023 short-term capital gains tax rates
Short-term capital gains are taxed as ordinary income, meaning the rates are the same as for the income you earn from your job or any other earned income source and therefore range from 10% to 37%. Because of marginal tax brackets, your effective tax rate (meaning the average tax rate you pay on all your income) will actually likely fall somewhere between one of these tax rates.
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 10% | $0 to $10,275 | $0 to $20,550 | $0 to $10,275 | $0 to $14,650 |
| 12% | $10,276 to $41,775 | $20,551 to $83,550 | $10,276 to $41,775 | $14,651 to $55,900 |
| 22% | $41,776 to $89,075 | $83,551 to $178,150 | $41,776 to $89,075 | $55,901 to $89,050 |
| 24% | $89,076 to $170,050 | $178,151 to $340,100 | $89,076 to $170,050 | $89,051 to $170,050 |
| 32% | $170,051 to $215,950 | $340,101 to $431,900 | $170,051 to $215,950 | $170,051 to $215,950 |
| 35% | $215,951 to $539,900 | $431,901 to $647,850 | $215,951 to $323,925 | $215,951 to $539,900 |
| 37% | $539,901 or more | $647,851 or more | $323,926 or more | $539,901 or more |
Remember that tax brackets can change slightly from year to year. Below are the short-term capital gains tax rates for 2023, which are a bit different from those for 2022.
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 10% | $0 to $11,000 | $0 to $22,000 | $0 to $11,000 | $0 to $15,700 |
| 12% | $11,001 to $44,725 | $22,001 to $89,450 | $11,001 to $44,725 | $15,701 to $59,850 |
| 22% | $44,726 to $95,375 | $89,451 to $190,750 | $44,726 to $95,375 | $59,851 to $95,350 |
| 24% | $95,376 to $182,100 | $190,751 to $364,200 | $95,376 to $182,100 | $95,351 to $182,100 |
| 32% | $182,101 to $231,250 | $364,201 to $462,500 | $182,101 to $231,250 | $182,101 to $231,250 |
| 35% | $231,251 to $578,125 | $462,501 to $693,750 | $231,251 to $346,875 | $231,251 to $578,100 |
| 37% | $578,126 or more | $693,751 or more | $346,876 or more | $578,101 or more |
2023-2023 long-term capital gains tax rates
While short-term capital gains are taxed at your ordinary income tax rate, long-term capital gains are taxed at special tax rates that are lower than those for short-term capital gains. Below are the long-term capital gains tax rates for 2022.
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 0% | $0 to $41,675 | $0 to $83,350 | $0 to $41,675 | $0 to $55,800 |
| 15% | $41,676 to $459,750 | $83,351 to $517,200 | $41,676 to $258,600 | $55,801 to $488,500 |
| 20% | $459,751 or more | $517,201 or more | $258,601 or more | $488,501 or more |
Below are the long-term capital gains tax rates for 2023.
| Tax Rate | Single | Married Filing Jointly | Married Filing Separately | Head of Household |
|---|---|---|---|---|
| 0% | $0 to $44,625 | $0 to $89,250 | $0 to $44,625 | $0 to $59,750 |
| 15% | $44,625 to $492,300 | $89,251 to $553,850 | $44,626 to $276,900 | $59,751 to $523,050 |
| 20% | $492,301 or more | $553,851 or more | $276,901 or more | $523,051 or more |
How are capital gains taxes calculated?
When you’re filling out your annual income tax return, you’ll have to calculate your capital gains taxes owed to ensure you aren’t underpaying (or overpaying) your taxes. The good news is that while determining your capital gains tax rate sounds complicated, it’s actually fairly easy to do.
There are two tax forms you’ll need to calculate and report your capital gains taxes: Form 8949 and Form 1040 Schedule D.
First, you’ll use Form 8949 to calculate your short-term and long-term capital gains and losses. Remember that unless you sell an asset for the exact same amount you bought it for, you likely had either a gain or a loss. Here’s how to calculate the capital gain on an asset:
- Determine your cost basis: Your basis in an asset is usually the price you bought it for, plus any commission or fees. For example, if you buy a stock for $10 and don’t pay any commission, then your basis in the stock is $10.
- Determine the sale price: To calculate your capital gain (or loss) on an asset, you’ll need to know how much you sold it for. In many cases, you can find this information on a tax form you’ll receive from your brokerage firm.
- Subtract your basis from the sale price: The difference between the amount you paid for an asset and the amount you sold it for is your capital gain. If the amount you sold it for was less than what you paid for it, you’ve had a capital loss.
- Record the transaction: Once you've gathered all of the information on the sale of any of your assets, you’ll record them on Form 8949. Keep in mind that the form is separated into short-term and long-term gains, so you’ll want to be careful to record each one in the right place.
- Calculate your net gain or loss: After you’ve recorded all of your capital gains and losses, you’ll use Form 8949 to calculate your net gain or loss. You’ll do this separately for short-term and long-term assets, meaning you will have two separate gains or losses to report. When calculating your net gain, you’ll use capital losses to offset your capital gains. For example, if you had a long-term capital gain of $100 on one asset and a capital loss of $100 on another asset, then your net long-term capital gain is $0.
- Report your gains or losses: Once you’ve completed Form 8949, you’ll use Form 1040 Schedule D to record your net gains or losses. Then, follow the instructions on Schedule D to calculate your capital gains taxes owed. If your capital losses exceed your capital gains, then you can take a deduction instead of paying capital gains taxes. Remember, you’ll pay between 10% and 37% for short-term capital gains and between 0% and 20% for long-term capital gains.
Find out more:Â How to claim a stock loss on taxes
Schedule D — as well as any capital gains taxes you owe — is due on tax day. In most years, tax day is April 15, but in 2023, it falls on April 18. It is possible to get an extension on your tax return until October 16, but the taxes you owe will still be due April 18 to be considered on time. If you pay later than that, you could be subject to fines and interest.
When do you pay capital gains taxes?
Capital gains taxes apply to realized gains, meaning only after you’ve sold an asset. For example, suppose you bought a stock at $10 and its price had increased to $15. As long as you hold the stock, you aren’t taxed on the increase in its value. It’s not until you sell that you’ve realized your gain and will have to pay taxes on it. The rate you’ll pay depends on whether it was a short-term or long-term capital gain.
The good news is that there are some transactions for which you won’t pay capital gains taxes. For example, the federal government has special rules for the sale of a permanent residence. As long as you’ve lived in a home for at least two years, the first $250,000 of gains (or $500,000 for married couples filing jointly) is exempt from capital gains taxes.
Let’s say you buy some real estate for $250,000 and sell it four years later for $550,000. The first $250,000 of gains are exempt from capital gains taxes, meaning you would only pay taxes on $50,000 of your $300,000 gain.
However, imagine that while you owned the home, you made renovations (such as increasing the square footage or adding additional bedrooms) that improved its value. In that case, you could add the cost of those renovations onto your basis. If you spent $50,000 on those improvements, your new basis would be $300,000 instead of $250,00, and you wouldn’t pay any capital gains taxes.
How to minimize capital gains taxes
Capital gains taxes can increase your overall tax burden, but there are ways to minimize your capital gains taxes and, therefore, minimize the total amount you owe in taxes.
Hold your assets for at least one year
Remember that taxes on assets you’ve held for less than one year are higher than those on assets you’ve held longer than one year. One of the best ways to reduce your tax burden is to hold onto your assets longer. Once you’ve held the asset for at least one year and are eligible for long-term capital gains taxes, you may feel more comfortable selling.
Invest in retirement accounts
Retirement accounts such as 401(k) plans and individual retirement accounts (IRAs) have special tax advantages. These accounts are either tax-deferred or tax-free, meaning you don’t pay taxes — capital gains taxes or any kind — as long as the money remains in the account.
Claim your losses
As we mentioned previously, you can offset your capital gains with capital losses. So if you had a $100 capital gain on one asset but a $100 capital loss on another, you can use your capital loss to offset your gain and pay no capital gains taxes.
If your capital losses exceed your capital gains, you have the option of deducting up to $3,000 in losses, which will reduce your taxable income and, therefore, your income taxes due. The IRS also gives you the option of carrying over your capital losses to offset capital gains in a future year.
You can even create a capital loss by selling an underperforming security. Let’s say you bought 100 shares of stock a few years ago at $20 per share, but lately, the stock price has been lingering around $15 per share. You could sell your shares to create a $500 loss, which you can use to offset a $500 gain on a different asset.
Use a robo-advisor
Robo-advisors use tax-efficient strategies to reduce your tax burden. As we suggested above, they may automatically sell underperforming assets to offset capital gains.
Robo-advisors also use tax-loss harvesting, a strategy where you sell an asset at a loss, often, in turn, purchasing a different asset. If you try tax-loss harvesting on your own, make sure you don’t repurchase the same security within 30 days, or you’ll have violated the IRS’ wash sale rule, which will cause you to lose your tax benefit.
Find out more:Â How to avoid capital gains tax on your investments
Capital gains special rates and exceptions
In almost all cases, you’ll pay ordinary income tax rates on assets held for less than one year and the special long-term capital gains tax rates on assets held for more than one year. However, there are a few exceptions that require you to pay a special tax rate.
One situation where you’ll pay a special tax rate is in the case of selling Section 1202 qualified small business stock. The Internal Revenue Code allows for special tax treatment when you sell stock from a small business. This exception excluded this type of stock from capital gains taxes, but only up to the greater of $10 million or 10 times your adjusted basis in the stock. The taxable portion of your gain from selling stock from a small business will be taxed at a rate of up to 28%.
Collectibles are another exception to the normal capital gains tax rates. Rather than being taxed at short-term or long-term capital gains rates, your net gain on these sales will be taxed at a rate of up to 28%. For the purpose of this law, collectibles can include artwork, antiques, coins, historical objects, and other personal property defined as collectibles.
Finally, there is a special tax treatment for unrecaptured Section 1250 gains. This income tax provision is designed to recapture the portion of a gain where there was a depreciation allowance used. The portion of the sale price that was previously depreciated is taxed at a rate of 25% instead of the normal capital gains tax rate.
Need help navigating all these rules? You can use the service of a tax specialist like TurboTax to make sure you get all the help you need. You can find out more about their services in our TurboTax review.
Bottom line
Capital gains may be a necessary part of life if you’re going to invest. The rate you’ll pay depends on two factors: how long you hold your asset and your household income. Luckily, you can easily reduce your capital gains tax burden by holding assets longer, investing in retirement accounts, offsetting your gains with losses, and employing the help of a robo advisor that uses tax-efficient investing strategies.
