Long-Term vs. Short-Term Capital Gains

Claire Boyte-White is the lead writer for NapkinFinance.com, co-author of I Am Net Worthy, and an Investopedia contributor. Claire's expertise lies in corporate finance & accounting, mutual funds, retirement planning, and technical analysis.

Lea Uradu, J.D. is a Maryland State Registered Tax Preparer, State Certified Notary Public, Certified VITA Tax Preparer, IRS Annual Filing Season Program Participant, and Tax Writer.

Tax Basics for Investors

1. Tax-Efficient Investing: A Beginner's Guide
2. Investment Tax Basics
3. Tax Tips for the Investor
4. Capital Gains and Taxes
5. Long and Short Tax Rates

Tax Considerations By Account

1. How Is a Roth 401(k) Taxed?
2. 401(k) Rollovers
3. Taxes on Mutual Funds
4. Converting to a Roth IRA

Tax-Deferred vs. Tax-Exempt

1. Tax-Deferred Savings Plan
2. Non Tax-Deferred Retirement Accounts
3. Tax-Exempt Sector

Smart Investing Strategies

1. Tax-Savvy Investment Strategies
2. Asset Allocation
3. Tax-Loss Harvesting
4. Annual Tax-Loss Harvesting

1. Maximize Retirement Plan Withdrawals
2. Avoid Overpaying Taxes
3. IRA Withdrawal Taxes

Long-Term vs. Short-Term Capital Gains: An Overview

When you sell a capital asset for more than its original purchase price, the result is a capital gain. This capital gain is taxed differently depending on how long you held the capital asset for. If you didn't hold it for a while, your gain may be taxed upwards of 37%. If you did hold it for a while, your rate may be less than 15% (and even $0 in some cases).

In this article, we'll look at what the difference is between a long-term and short-term capital gain, how they are treated differently, and what you can do to minimize your tax liability.

Key Takeaways

• Selling a capital asset after owning it for one year or less results in a short-term capital gain.
• Selling a capital asset after owning it for more than one year results in a long-term capital gain.
• Capital assets include stocks, bonds, precious metals, jewelry, art, and real estate.
• Short-term capital gains are taxed as ordinary income; long-term capital gains are subject to a tax of 0%, 15%, or 20% (depending on your income).
• There is a flat 28% capital gains tax on gains related to art, antiques, jewelry, precious metals, stamp collections, coins, and other collectibles regardless of your income.

Comparing Long-Term vs Short-Term Capital Gains

Understanding Long-Term and Short-Term Capital Gains

Capital assets include stocks, bonds, precious metals, jewelry, and real estate. The tax that you’ll pay on the capital gain depends on how long you held the asset before selling it. Capital gains are classified as either long- or short-term and are taxed accordingly.

It’s important to keep capital gains taxes in mind whenever you sell an asset, especially if you day trade online. First, any profits that you make are taxable. Second, you may have heard that capital gains are taxed more favorably than other types of income, but that’s not always the case. As mentioned above, it depends on how long you owned those assets before you sold them.

Long-term capital gains are derived from assets that are held for more than one year before they are sold. Long-term capital gains are taxed at 0%, 15%, or 20%, according to graduated income thresholds. The tax rate for most taxpayers who report long-term capital gains is 15% or lower.

Short-term capital gains are taxed as ordinary income. That rate can go up to 37% in 2023, depending on your tax bracket.

Key Differences

A short-term capital gain results from the sale of an asset owned for one year or less. While long-term capital gains are generally taxed at a more favorable rate than salary or wages, short-term gains do not benefit from any special tax rates. They are subject to taxation as ordinary income.

As regular taxable income, short-term gains are subject to the tax appropriate for your marginal income tax bracket. There are currently seven U.S. federal tax brackets, with rates ranging from 10% to 37%.

Net capital gains are calculated based on your adjusted basis in an asset. This is the amount that you paid to acquire the asset, less depreciation, plus any costs that you incurred during the sale of the asset and the costs of any improvements that you made. If an asset is given to you as a gift, then you inherit the donor’s basis.

The tax on a long-term capital gain is almost always lower than that for a short-term capital gain. Because of this difference in taxation, you can minimize your capital gains tax by holding assets for more than a year.

Long-Term Capital Gains Tax Rates

After the passage of the Tax Cuts and Jobs Act (TCJA), the tax treatment of long-term capital gains changed. Before 2018, the tax brackets for long-term capital gains were closely aligned with income tax brackets. The TCJA created unique tax brackets for long-term capital gains tax. These numbers generally change from year to year.

Source: Internal Revenue Service

Short-Term Capital Gains Tax Rates

Short-term capital gains are taxed as ordinary income. Any income that you receive from investments that you held for one year or less must be included in your taxable income for that year. For example, if you have $90,000 in taxable income from your salary and $10,000 from short-term investments, then your total taxable income is $100,000.

The tax that you’ll pay on short-term capital gains follows the same tax brackets as ordinary income.

Source: Internal Revenue Service

Ordinary income is taxed at rates that increase as your income increases. It’s possible that a short-term capital gain (or at least part of it) might be taxed at a higher rate than your regular earnings. That’s because it might cause part of your overall income to jump into a higher marginal tax bracket.

Let's use our above example of a $90,000 salary and $10,000 short-term capital gain. Given the 2023 federal income tax rates, and assuming you are filing as a single person, you would be in the 22% tax bracket. However, because of the progressive nature of the federal tax system, the first $11,000 that you earn would be taxed at 10%, your income from over $11,000 up to $44,725 would be taxed at 12%, and only the income from over $44,725 to $95,375 would be taxed at 22%.

Continuing with the example, the portion of your $10,000 short-term capital gain that can be allotted to the $95,375 limit for the bracket (given your $90,000 salary) is $5,375. That figure would be taxed at 22%. The remaining $4,625 of the gain, however, would be taxed at 24%, the rate for the next highest tax bracket.

Make sure you consult an accountant or other financial professional who can help guide you through the process if you have trouble understanding how capital gains affect your tax bracket and overall tax liability.

Capital Gains and State Taxes

Whether you also pay capital gains to the state depends on where you live. Some states also tax capital gains, while others have no capital gains taxes or favorable treatment of them. The following states have no income taxes and no capital gains taxes:

• Alaska
• Florida
• Nevada
• New Hampshire
• South Dakota
• Tennessee
• Texas
• Washington
• Wyoming
  

Several states offer either a credit, deduction, or exclusion. For example, Colorado offers an exclusion on real or tangible property, and New Mexico offers a deduction on federally taxable gains. Montana has a credit to offset part of any capital gains tax. Washington state implemented a 7% tax on long-term net capital gains in excess of $250,000 beginning Jan. 1, 2022.

Investopedia's Tax Savings Guide can help you maximize your tax credits, deductions, and savings.

Which Assets Are Counted As Capital Gains?

Some assets receive different capital gains treatment or have different time frames than the rates indicated above.

Collectibles

You’re taxed at a 28% rate—regardless of your income—for gains on art, antiques, jewelry, precious metals, stamp collections, coins, and other collectibles.

Qualified Small Business Stock

The tax treatment of a qualified small business (QSB) stock depends on when the stock was acquired, by whom, and how long it was held. To qualify for this exemption, the stock must have been acquired from a QSB after Aug. 10, 1993, and the investor must be a noncorporate entity that held the stock for at least five years.

A QSB is generally defined as a domestic C corporation with aggregate gross assets that have never exceeded $50 million at any point since Aug. 10, 1993. Aggregate gross assets include the amount of cash held by the company, as well as the adjusted bases of all other property owned by the corporation. Additionally, the QSB must file all required reports.

Only certain types of companies fall under the category of a QSB. Firms in the technology, retail, wholesale, and manufacturing sectors are eligible as QSBs, while those in the hospitality industry, personal services, financial sector, farming, and mining are not.

This exemption originally allowed the taxpayer to exclude 50% of any gain from the sale of QSB stock. However, it was later increased to 75% for QSB stock acquired from Feb. 18, 2009, to Sept. 27, 2010, and then to 100% for QSB stock acquired after Sept. 27, 2010. The gain that is eligible for this treatment has a cap of $10 million, or 10 times the adjusted basis of the stock—whichever is greater.

Home Sale Exclusion

There’s a special capital gains arrangement if you sell your principal residence. The first $250,000 of an individual’s capital gains on the sale of your principal residence is excluded from taxable income ($500,000 for those married filing jointly), as long as the seller has owned and lived in the home for two of the five years leading up to the sale. If you sold your home for less than you paid for it, this loss is not considered tax deductible, because capital losses from the sale of personal property, including your home, are not tax deductible.

For example, a single taxpayer who purchased a house for $300,000 and sold it for $700,000 made a $400,000 profit on the sale. After they apply the $250,000 exemption, they must report a capital gain of $150,000. This is the amount subject to the capital gains tax.

In most cases, significant repairs and improvements can be added to the base cost of the house. These can serve to further reduce the amount of taxable capital gain. If you spent $50,000 to add a new kitchen to your home, this amount could then be added to the $300,000 original purchase price. This would raise the total base cost for capital gains calculations to $350,000 and lower the taxable capital gain from $150,000 to $100,000.

Investment Real Estate

Investors who own real estate are often allowed to apply deductions to their total taxable income based on the depreciation of their real estate investments. This deduction is meant to reflect the steady deterioration of the property as it ages, and it essentially reduces the amount that you’re considered to have paid for the property in the first place. This also has the effect of increasing your taxable capital gain when the property is sold.

For example, if you paid $200,000 for a building and are allowed to claim $5,000 in depreciation, then you’ll be treated subsequently as if you had paid $195,000 for the building. If you then sell the real estate, the $5,000 is treated as recapturing those depreciation deductions. The tax rate that applies to the recaptured amount is 25%.

So if you sold the building for $210,000, there would be total capital gains of $15,000. But $5,000 of that figure would be treated as a recapture of the deduction from income. That recaptured amount is taxed as ordinary income but is capped at the maximum rate of 25%. The remaining $10,000 of capital gain would be taxed at one of the 0%, 15%, or 20% rates indicated above.

Investment Exceptions

High-income earners may be subject to another tax on their capital gains: the net investment income tax. This tax imposes an additional 3.8% on your investment income, including your capital gains if your modified adjusted gross income (MAGI) exceeds certain maximums: $250,000 if married and filing jointly or you’re a surviving spouse, $200,000 if you’re single or a head of household, and $125,000 if married and filing separately.

Advantages of Long-Term Capital Gains

It can be advantageous to keep investments longer if they will be subject to a capital gains tax once they’re realized.

The tax rate will be lower for most people if they realize a capital gain after one year. For example, suppose you bought 100 shares of XYZ Corp. stock at $20 per share and sold them at $50 per share. Your regular income from earnings is $100,000 a year, and you file taxes jointly with your spouse. The chart below compares the taxes that you would pay when you sold the stock after more than a year vs. after less than a year.

*This chart shows how a married couple filing jointly earning $100,000 a year could avoid more than $200 in taxes by waiting over one year before selling shares that had appreciated $3,000.

You would pay $450 of your profits by opting for a long-term investment gain and being taxed at the long-term capital gains rate. But had you held the stock for one year or less (and hence incurred a short-term capital gain), your profit would have been taxed at your ordinary income tax rate. For our $100,000-a-year couple, that would trigger a tax rate of 22%, the applicable rate for income over $89,450 in 2023. That adds an additional $210 to the capital gains tax bill, for a total of $660.

While it’s possible to make a higher return by cashing in your investments frequently and repeatedly shifting the funds to fresh new investment opportunities, that higher return may not compensate for higher short-term capital gains tax bills. Making constant changes in investment holdings, resulting in high payments of capital gains tax and commissions, is called churning when it's done by a broker.

Do Long-Term Capital Gains Rates Ever Change?

Both long-term capital gains rates and short-term capital gains rates are subject to change, depending on prevailing tax legislation. Most often, the rates will change every year in consideration and relation to tax brackets; individuals who have earned the same amount from one year to the next may notice that, because of changes to the cost of living and wage rates, their capital gains rate has changed. It is also possible for legislation to be introduced that outright changes the bracket ranges or specific tax rates.

How Do I Calculate Capital Gain on the Sale of Property?

You must first determine your basis in the property. Your basis is your original purchase price plus any fees that you paid minus any depreciation taken. Next, determine your realized amount. Your realized amount is the price that you’re selling the property for minus any fees paid by you. Finally, you need to subtract your basis from your realized amount. If the figure is positive, then you will have a capital gain. If the figure is negative, then you will have a capital loss.

Will My Long-Term Capital Gains Push Me Into a Higher Ordinary Income Tax Bracket?

Your long-term capital gains will not cause your ordinary income to be taxed at a higher rate. Ordinary income is calculated separately and taxed at ordinary income rates. More long-term capital gains may push your long-term capital gains into a higher tax bracket (0%, 15%, or 20%), but they will not affect your ordinary income tax bracket.

However, if you had short-term capital gains, then they would increase your ordinary income and potentially push you into the next marginal ordinary income tax bracket.

The Bottom Line

The tax on a long-term capital gain is almost always lower than if the same asset were sold in a year or less. Most taxpayers don’t have to pay the highest long-term rate. Tax policy encourages you to hold assets subject to capital gains for more than a year.