How Are Capital Gains Taxed?

March 18, 2024 Hayden Adams Beginner
When an asset is sold for a profit, Uncle Sam wants his share. Depending on your income level, your capital gains rate might be lower than your ordinary tax rate.

Delving into the labyrinth of capital gains taxation unveils a complex web of financial intricacies that every investor must navigate. When investments appreciate and are sold, they become subject to taxation, with the treatment of these gains varying based on factors like how long you owned the investment and how much taxable income you have that year. Understanding the intricacies of how capital gains are taxed is essential for anyone looking to minimize taxes, while staying compliant with the IRS rules. 

Let’s look at a few key questions to about the taxation of capital gains. 

What are capital gains?

Any time you sell an investment for more than you bought it, you potentially create a taxable capital gain. Capital gains can apply to almost any investment that is sold at a profit, such as stocks, bonds, real estate, precious metals, options contracts, or even cryptocurrency. 

When you sell an investment at a profit, the difference between the selling price and the purchase price (a.k.a cost basis) is considered a capital gain. Fortunately, you can potentially reduce the gain you realize a bit by including certain expenses like the costs incurred to sell the asset. 

Learn more about calculating your capital gains taxes: Save on Taxes: Know Your Cost Basis.

Are all investment sales subject to capital gains taxes?

No, there are many times when selling an asset does not result in a taxable gain. Capital gains taxes generally only apply to assets held in a taxable account like a bank or brokerage account. Assets held in tax-advantaged accounts, such as an IRA or 401(k), avoid capital gains taxes on the sale of an asset. 

How are capital gains taxed?

At the federal level, capital gains are taxed based on the several factors including the type of asset, how long you held the asset, and your overall income level. 

If you only held the investment for a year or less, then the short-term capital gains tax rates will apply. These tax rates and brackets are the same as those applied to ordinary income, like your wages, and currently range from 10% to 37% depending on your income level.

2024 short-term capital gains tax rates and brackets
  • Tax rate
    Tax rate
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Tax rate
  • Taxable income bracket
    Single filer
  • Taxable income bracket
    Married filing jointly
  • Taxable income bracket
    Married filing separately
  • Taxable income bracket
    Filing head of household
  • Tax rate
    0%
  • Taxable income bracket
    Standard or itemized deduction amount
  • Taxable income bracket
    Standard or itemized deduction amount
  • Taxable income bracket
    Standard or itemized deduction amount
  • Taxable income bracket
    Standard or itemized deduction amount
  • Tax rate
    10%
  • Taxable income bracket
    $0 – $11,600
  • Taxable income bracket
    $0 – $23,200
  • Taxable income bracket
    $0 – $11,600
  • Taxable income bracket
    $0 – $16,550
  • Tax rate
    12%
  • Taxable income bracket
    $11,601 – $47,150
  • Taxable income bracket
    $23,201 – $94,300
  • Taxable income bracket
    $11,601 – $47,150
  • Taxable income bracket
    $16,551 – $63,100
  • Tax rate
    22%
  • Taxable income bracket
    $47,151 – $100,525
  • Taxable income bracket
    $94,301 – $201,050
  • Taxable income bracket
    $47,151 – $100,525
  • Taxable income bracket
    $63,101 – $100,500
  • Tax rate
    24%
  • Taxable income bracket
    $100,526 – $191,950
  • Taxable income bracket
    $201,051 – $383,900
  • Taxable income bracket
    $100,526 – $191,950
  • Taxable income bracket
    $100,501 – $191,950
  • Tax rate
    32%
  • Taxable income bracket
    $191,951 – $243,725
  • Taxable income bracket
    $383,901 – $487,450
  • Taxable income bracket
    $191,951 – $243,725
  • Taxable income bracket
    $191,951 – $243,700
  • Tax rate
    35%
  • Taxable income bracket
    $243,726 – $609,350
  • Taxable income bracket
    $487,451 – $731,200
  • Taxable income bracket
    $243,726 – $365,600
  • Taxable income bracket
    $243,701 – $609,350
  • Tax rate
    37%
  • Taxable income bracket
    $609,351 or more
  • Taxable income bracket
    $731,201 or more
  • Taxable income bracket
    $365,601 or more
  • Taxable income bracket
    $609,350 or more

On the other hand, if you held the investments longer than a year, long-term capital gains tax rates will apply and any gains are subject to lower preferential tax rates, ranging from 0% to 20% depending on your income level. 

2024 long-term capital gains tax rates and brackets
  • Tax rate
    Tax rate
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Taxable income bracket
    Taxable income bracket
  • Tax rate
  • Taxable income bracket
    Single filer
  • Taxable income bracket
    Married filing jointly
  • Taxable income bracket
    Married filing separately
  • Taxable income bracket
    Filing head of household
  • Tax rate
    0%
  • Taxable income bracket
    $0 – $47,025
  • Taxable income bracket
    $0 – $94,050
  • Taxable income bracket
    $0 – $47,025
  • Taxable income bracket
    $0 – $63,000
  • Tax rate
    15%
  • Taxable income bracket
    $47,026 – $518,900
  • Taxable income bracket
    $94,051 – $583,750
  • Taxable income bracket
    $47,026 – $291,850
  • Taxable income bracket
    $63,001 – $551,350
  • Tax rate
    20%
  • Taxable income bracket
    $518,901 or more
  • Taxable income bracket
    $583,750 or more
  • Taxable income bracket
    $291,850 or more
  • Taxable income bracket
    $551,350 or more

Additionally, high-income earners may also be subject to the net investment income tax (NIIT), which adds an extra 3.8% tax on investment income, including capital gains, for individuals with modified adjusted gross income (AGI) above certain thresholds. 

Net investment income tax (NIIT)
  • Tax rate
    Tax rate
  • Additional 3.8% tax if income is above the limits below 
    Additional 3.8% tax if income is above the limits below 
  • Additional 3.8% tax if income is above the limits below 
    Additional 3.8% tax if income is above the limits below 
  • Additional 3.8% tax if income is above the limits below
    Additional 3.8% tax if income is above the limits below
  • Additional 3.8% tax if income is above the limits below 
    Additional 3.8% tax if income is above the limits below 
  • Tax rate
  • Additional 3.8% tax if income is above the limits below 
    Single filer
  • Additional 3.8% tax if income is above the limits below 
    Married filing jointly
  • Additional 3.8% tax if income is above the limits below
    Married filing separately
  • Additional 3.8% tax if income is above the limits below 
    Filing head of household
  • Tax rate
    AGI limits
  • Additional 3.8% tax if income is above the limits below 
    $200,000
  • Additional 3.8% tax if income is above the limits below 
    $250,000
  • Additional 3.8% tax if income is above the limits below
    $125,000
  • Additional 3.8% tax if income is above the limits below 
    $200,000

And remember, state taxes could also apply. Each state has its own rules about how the gains are taxed, and some states don’t tax these gains at all. 

Are there any unique capital gains tax rules?

There are many other asset classes out there with their own unique tax rules. For instance, futures contracts, options on futures, options on broad-based indexes, and collectables (which includes metals like gold) are subject to a special tax treatment.  

Derivative contracts like futures contracts, options on futures, or options on broad-based indexes, are subject to Internal Revenue Code section 1256 (a.k.a 1256 contracts). These types of assets get special tax treatment called the 60/40 rule, where 60% of gains are taxed at the lower long-term capital gains rate and 40% at the ordinary income tax rate. In addition, if you hold section 1256 contracts, they're subject to the mark-to-market rule. If you hold these assets through the end of a calendar year, you'll have to recognize an unrealized gain or loss based on the fair market value on December 31. 

Gains from the sale of collectibles, such as art, antiques, coins, and precious metals, are subject to a higher long-term capital gains tax rate of 28%. Whereas shorter-term gains on collectables are taxed at the ordinary income tax rates.

How are cryptocurrencies treated when it comes to taxes?

Cryptocurrencies are taxed a bit different than most people expect. While cryptocurrencies, like bitcoin, are often thought of as digital currencies, the IRS disagrees. The IRS does not consider them to be a currency; in the IRS’s eyes, they are "property," which means cryptocurrencies are subject to the same long- and short-term capital gains tax rates as other investments. 

When you sell or trade cryptocurrencies for another asset (or even for a different cryptocurrency), you create a taxable event, and any gain realized needs to be reported on your tax return. Even if you don’t get a Form 1099 for a cryptocurrency transaction, it still needs to be reported on your tax return. Also be aware that using cryptocurrency to buy goods or services is also a taxable event because you exchanged the cryptocurrency for something. 

What happens if I realize a capital loss on a sale?

No one likes losing money, but sometimes, losses are unavoidable. If you sell an investment for less than you paid for it, a capital loss has been realized. Fortunately, investment losses have a silver lining; you can use capital losses to offset other capital gains, reducing your overall tax bill. If total capital losses exceed your capital gains, you can deduct up to $3,000 of the excess losses against other types of income, such as wages. Any remaining losses beyond the $3,000 deduction can be carried forward to offset future income. 

The tax benefits from capital losses are often good enough that many tax savvy investors regularly look for losses in their portfolios so they can use them to reduce their taxes in a process known as tax-loss harvesting. But you do have to be careful when strategically realizing losses to avoid the wash sale rule, which could reduce or remove the potential tax benefits of loss harvesting.

Could tax rates for long-term gains change?

It's always possible. In the end, Congress writes the tax laws, so it always has the option to change the tax rates and brackets. For example, back in the late 1970s, the maximum long-term capital gains rate rose to near 40% for some investors with the biggest gains. That’s why meeting with your tax and financial advisor at least once a year is important because they’re tracking those changes and can help update your wealth management plan accordingly. 

Bottom line

Navigating the complexities of capital gains taxes is crucial for investors seeking to optimize their overall wealth management strategy. Understanding the various tax rates, holding periods, and special rules for different asset classes can significantly impact your tax liabilities and investment decisions. Given the intricacies involved, it's prudent to seek professional guidance from a tax professional and/or a financial planner to get personalized advice tailored to your specific circumstances. 

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Schwab does not provide tax advice. Clients should consult a professional tax advisor for their tax advice needs. 

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