On this page
Calculation
Capital Gain = Sale Price - Purchase Price (Basis)
Example: Stock investment
- Buy Apple stock: $100
- Sell Apple stock: $150
- Capital gain: $50
- Tax: Depends on holding period
Short-Term vs. Long-Term Capital Gains
Short-term capital gains (held ≤ 1 year):
- Taxed as ordinary income
- 10-37% federal rates (plus state taxes)
- Example: Sell stock 11 months after buying, pay ordinary income rate
Long-term capital gains (held > 1 year):
- Preferential tax rates
- 0%, 15%, or 20% federal rates (much lower)
- Example: Sell stock 13 months after buying, pay capital gains rate
Tax brackets determine rates:
Single filer, long-term capital gains 2024:
- 0% rate: Up to $47,025 income
- 15% rate: $47,026-$518,900
- 20% rate: Over $518,900
Why Long-Term Rates Are Lower
Government incentivizes long-term investing:
- Lower rates encourage buy-and-hold
- Discourage short-term speculation
- Boost capital markets
As result: Holding 12 months changes tax from 37% (short-term) to 20% (long-term) for high-earners = 17% tax savings.
Real-World Example
Trader A (short-term):
- Buys stock at $100, sells at $150 after 6 months
- $50 gain
- Taxed at 37% (ordinary income)
- Taxes: $18.50
- After-tax profit: $31.50
Trader B (long-term):
- Buys stock at $100, sells at $150 after 13 months
- $50 gain
- Taxed at 20% (long-term rate)
- Taxes: $10
- After-tax profit: $40
Trader B nets $8.50 more purely from holding longer. Tax strategy matters.
Net Capital Gains
You can offset capital gains with capital losses:
Gains of $50,000, losses of $30,000:
- Net capital gain: $20,000
- Tax only on $20,000
Gains of $20,000, losses of $30,000:
- Net capital loss: $10,000
- Can deduct $3,000 against ordinary income
- Remaining $7,000 carries forward to next year
This is the basis of tax-loss harvesting strategies.
Capital Gains and Investment Accounts
Taxable account:
- Capital gains trigger taxes immediately upon sale
- If held long-term, taxed at preferential rates
401(k) or Traditional IRA:
- No capital gains tax on sales within the account
- All gains are tax-deferred (or tax-free for Roth)
- You only pay taxes on withdrawals
Roth IRA:
- No capital gains tax ever
- All gains are tax-free
This is why retirement accounts are superior to taxable accounts for long-term investing.
High-Earner Dynamics
For high earners, investment income becomes attractive:
Option A: Earn $100,000 wages
- Marginal tax rate: 37%
- After-tax: $63,000
Option B: Realize $100,000 capital gains
- Tax rate: 20%
- After-tax: $80,000
Difference: $17,000 more from capital gains tax rates.
This is why billionaires focus on wealth appreciation (capital gains) rather than income (salary). They pay far lower taxes on appreciation.
Stepped-Up Basis
One of the largest tax advantages:
Example: Your father buys stock for $100,000, it appreciates to $500,000, then he dies
With stepped-up basis:
- You inherit the stock with "stepped-up" basis to $500,000
- You immediately sell for $500,000
- Capital gain: $0
- Taxes: $0
Without stepped-up basis:
- You inherit at $100,000 basis
- You sell for $500,000
- Capital gain: $400,000
- Taxes: ~$80,000 (at 20% long-term rate)
Stepped-up basis is worth enormous amounts to wealthy families. It's scheduled to potentially go away under SECURE Act 2.0 for very wealthy estates.
Tax-Loss Harvesting
Strategy to minimize capital gains taxes:
Scenario: You have $30,000 capital gain, $10,000 capital loss
- Net: $20,000 taxable gain
- Taxes: ~$4,000
Tax-loss harvesting: Sell losing positions
- Realize the $10,000 loss
- Offset the $30,000 gain
- Net: $20,000 gain (same)
- But you can control timing
Benefit: Harvest losses in down years, recognize gains in high-income years, minimize taxes.
Qualified Small Business Stock
Special rule: 50% of long-term capital gains from qualified small business stock can be excluded from taxes.
Example: $100,000 gain
- 50% exclusion: $50,000 excluded
- 50% taxable: $50,000 × 20% = $10,000 taxes
- vs. normal $20,000 taxes
This incentivizes investment in small businesses.
Holding Period Matters
The difference between 12 months and 13 months is significant:
Sell at 12 months:
- Short-term capital gains
- Taxed at ordinary rates (up to 37%)
Sell at 13 months:
- Long-term capital gains
- Taxed at preferential rates (20% max)
Tax difference on $100,000 gain: $17,000 for a high-earner
Wait one month, save $17,000. This is why holding period matters.
State Capital Gains Taxes
Some states tax capital gains:
California: 13.3% state + 20% federal = 33.3% total on long-term gains
Texas: 0% state + 20% federal = 20% total
New York: ~10.9% state + 20% federal = 30.9% total
State tax differences create incentives for wealthy people to move. billionaires move to Texas (no state income tax) to avoid California's 13.3% state capital gains tax.
The Bottom Line
Capital gains tax is lower for long-term holdings, incentivizing long-term investment. The preferential 0-20% long-term rates are dramatically better than ordinary income rates (up to 37%).
For wealth building, focusing on capital appreciation (long-term gains) is more tax-efficient than income (wages, interest). This is why passive investing in stocks beats trying to earn high income through work.
