Takeaways
- Capital gains are realized when you sell an asset above its purchase price.
- Capital gains apply to both personal and investment capital assets.
- Capital gains taxes are due when you sell an asset for a profit.
- Short-term capital gains are applied to a capital asset when held for less than a year.
- Long-term capital gains are earned if you hold the asset for over one year.
Both beginner investors and experienced pros need a firm grasp of taxes. Tax planning and understanding how capital gains tax work can save your portfolio thousands of dollars and juice your long-term investment returns. Achieving your financial goals requires choosing the best investments, consistent capital deployment, managing costs, and keeping taxes low.
Here, we navigate one of the most relevant tax issues for anyone trading stocks, real estate, cryptocurrency, bonds, or other investments in one of the many asset classes: capital gains.
What Are Capital Gains?
A capital asset is virtually any asset you own for personal use, such as a car, boat, and house, and investment purposes, like stocks, corporate bonds, or a rental property.[1]
When you sell a capital asset, the difference between your purchase and selling prices determines if you earn a capital gain or loss. If you receive more than you paid, you earn a capital gain. Conversely, you will incur a capital loss if you sell the capital asset for less than its purchase price.
For example, if you bought a used car for $20,000 and sold the car for $25,000, you have earned a $5,000 capital gain. Depending on how long you owned the vehicle will determine if you own a short-term or long-term capital gains tax on your profit.
Institutional investors and retail investors tend to focus on accumulating capital gains, although there can be reasons to intentionally accrue capital losses (more on that below).
How Capital Gains Taxes Work
Capital gains taxes are the taxes you pay when you sell a capital asset above its purchase price. The length of time you have owned the asset determines if it falls into the short-term or long-term capital gains tax category. Other factors besides your holding period also matter in determining how much capital gains tax you will owe once you file your taxes.
Here’s how it works. If you have owned a capital asset for less than a year before you sell it, you pay your ordinary taxes on the capital gain. Depending on your tax bracket, you could pay as much as 37% or more on your short-term capital gain. However, if you owned the asset for a year or more, your capital gain falls into a long-term bucket.
Holding the asset for more than a year has advantages. If your holding period exceeds a year, you will be taxed at the more favorable long-term capital gains rate. Long-term capital gains are taxed between 0% and 20%, depending on your total table income for the year.
- Short-Term Capital Gains are applied if you profit from selling a capital asset you have held for less than a year. They are taxed at your ordinary income tax brackets. Depending on your income, they scale from 10%, 12%, 22%, 24%, 32%, 35% or 37%.
- Long-Term Capital Gains are created if you profit from selling a capital asset you have held for over a year. They are taxed in special capital income tax brackets, which depend on your taxable income. Long-term capital gain tax rates are 0%, 15%, and 20%.
2024 Capital Gains Tax Rates
| Filing Status | 0% | 15% | 20% |
|---|---|---|---|
| Single | Up to $47,025 | $47,026 to $518,900 | Over $518,900 |
| Head of Household | Up to $63,000 | $63,001 to $551,350 | Over $551,350 |
| Married Filing Jointly | Up to $94,050 | $94,051 to $583,750 | Over $583,750 |
| Married Filing Seperately | Up to $47,025 | $47,026 to $291,850 | Over $291,850 |
Source: Internal Revenue Service Website [2]
2025 Capital Gains Tax Rates
| Filing Status | 0% | 15% | 20% |
|---|---|---|---|
| Single | Up to $48,350 | $48,350 to $533,400 | Over $533,400 |
| Head of Household | Up to $64,750 | $64,750 to $566,700 | Over $566,700 |
| Married Filing Jointly | Up to $96,700 | $96,700 to $600,050 | Over $600,050 |
| Married Filing Seperately | Up to $48,350 | $48,350 to $300,000 | Over $300,000 |
Source: Internal Revenue Service Website [3]
5 Ways to Avoid Capital Gain Tax
Steering your portfolio away from paying unnecessary capital gains taxes is a smart strategy because it lets you keep more of what you have earned. Here are five strategies to implement to lower your tax burden:
- Not Selling Investments lets you avoid capital gains and losses. If you are stuck with a large tax bill and don’t want to increase it, don’t see your investments. You only pay taxes on realized or actual capital gains after a transaction.
- Rolling Capital Gains into New Investments can work, especially in some real estate transactions. For example, you see this type of structure when you sell your home. The Interval Revenue Service gives you a $250,000 capital gains exclusion when you sell your home if you use those funds to purchase another home. This allows you to make a profit and not pay taxes on those realized gains.
- Harness Tax Advantages Accounts to decrease your current tax burden. Retirement savings accounts like employee-sponsored 401(k) plans, 403(b) plans, and Traditional IRA accounts let your funds grow tax-free. You only pay taxes on your investment in these accounts once you start pulling funds in retirement. (Read more about how to retire early).
- Tax-Loss Harvesting lets you sell investments at a loss and use those losses to offset capital gains. This can minimize your total tax due when you file your taxes, but you need to plan for this as part of your overall financial planning.
- Buying Long-Term Assets gives you the freedom to ignore the stock market’s short-term machinations. Long-term institutional and retail investors often allocate a portion of their investment portfolio to a long-term time horizon. This investing strategy relieves the pressure of craving the need to capitalize on short-term gains.
When You Should Ignore Tax Optimization
Understanding when taxes should impact your investing strategy is incredibly important if you are investing for the long term. Here are three situations where you should probably ignore trying to maximize long-term capital gains treatment:
1. Volatile Investments
Highly volatile stocks and bonds might not be the best place to harness the power of trying to wait for long-term capital gains. Instead, you might need to focus on locking in investment gains, even if you haven’t held the stock for over a year. For example, a small market capitalization stock might be up 100% one day since your investment and down 20% the next. This can also happen with Bitcoin or other cryptocurrencies.
2. High Need for Cash
Sometimes, the best option is to liquidate a portion of your portfolio to convert an investment from a marketable security to cash. You might need money to pay off high-interest credit card debt, make a down payment for a home, or feel better with a larger slush fund. In these situations, you should ignore optimizing for long-term capital gains.
3. Investment Losses
Investors can sometimes sense when an investment is about to turn sour. For example, you might hold a stock that has made a strategic pivot you disagree with. In this case, it is a smart money move to convert unrealized gains into realized gains, regardless of capital gains tax treatment.
Smart Summary
Capital gains are applied when you sell a capital asset – like stocks, bonds, or real estate – for more than its purchase price. Tax treatment is based on how long you hold the asset; the longer you hold the asset, the less taxes you will pay. You will get favorable take treatment and incur lower tax rates for capital assets held more than a year. You will incur ordinary tax treatment if you have your investment for less than a year.
Frequently Asked Questions
Most tax filers pay capital gains at the annual tax filing, due by April 15, 2025. (Read more about how to file your taxes.)
Here is our curated list of the best tax filing software. Consider consulting with a tax professional if you have an extremely complicated tax situation.
When trading volatile investments like stocks or crypto, sometimes—even with the best of intentions—you might need to take your investment gains and walk away.
(1) Internal Revenue Service. Topic no. 409, Capital gains and losses. Last Accessed January 13, 2024.
(2) Internal Revenue Service. Internal Revenue Bulletin: 2023-48. Last Accessed January 13, 2025.
(3) Internal Revenue Service. Rev. Proc. 2024-40. Last Accessed January 13, 2025.
