Overview, Short-Term vs. Long-Term Capital Gains Taxes

The capital gains tax you pay on assets held for years, and mere months, both vary by your income, but they do so in different ways. Long-term capital gains, derived from investments held for more than one year, are taxed according to graduated thresholds for taxable income that impose capital-gains tax of 0%, 15%, or 20%. By contrast, a short-term capital gain, resulting from an asset owned for a year or less, is taxed as though it were ordinary income, with the rate being that of the tax bracket in which that income (including the capital gain) places you.

Because of this difference, the tax on a long-term capital gain is almost always less than if the same asset were sold (and the gain realized) quickly. Here's why: As income, short-term gains get hit with one of seven tax rates, corresponding to the seven tax brackets. Fully five of those rates exceed the highest possible rate (of 20%) you'll pay on a long-term capital gain. And only taxpayers with a taxable income that's upwards of $434,550 (single or married, filing jointly) are subject to that highest long-term rate.

In other words, tax policy encourages the holding for a year or more of the assets that are subject to capital gains, which include stocks, bonds, precious metals, and real estate. Keep in mind the differential tax bite for long- and short-term capital gains when weighing when to sell taxable assets.

Long-Term Capital Gains Tax Rates

If it's been a few years since you faced paying tax on long-term capital gains, be aware that the tax treatment of these has changed. Prior to 2018, long-term capital gains rates aligned closely with income-tax brackets, with the 0%, 15%, and 20% capital-gains rates applying to a specific brackets, or groups of brackets. Now, following the passage of the Tax Cuts and Jobs Act, long-term capital-gains tax essentially has brackets of its own. Here they are:

 

Filing Status

 

0% rate

 

15% rate

 

20% rate

 

Single

 

Up to $39,375

$39,376 to $434,550

Over $434,550

 

Head of household

Up to $52,750

 

$$52,751 to $461,700

Over $461,700

 

Married filing jointly 

Up to $78,750

$78,751 to $488,850

Over $488,850

 

Married filing separately

 

Up to $39,375

$39,376 to $244,425

Over $244,425

These figures represent taxable income in all cases.

Short-Term Capital Gains Tax Rates

Short-term capital gains are taxed as though they are ordinary income. Any income you receive from investments you held for less than a year must be included in your taxable income for that year, and then taxed accordingly. So if you have $80,000 in taxable income from salary, say, and $5,000 from short-term investments, your total taxable income would be $85,000.

Here are the federal tax brackets for 2019:

 

Filing Status

 

10%

 

12%

 

22%

24% 32% 35% 37%
 

Single

 

$0 to $9,699

$9,700 to $39,375

$39,376 to $82,199

$82,200 to $160,724 $160,725 to $204,099 $204,100 to $510,299 $510,300 or more
 

Head of household

$0 to $13,849

 

$13,850 to $52,849

$52,850 to $84,199

$84,200 to $160,699 $160,700 to $204,099  $204,100 to $510,299 $510,300 or more
 

Married filing jointly 

$0 to $19,399

$19,400 to $78,949 

$78,950 to $168,399   

$168,400 to $321,449  $321,450 to $408,199  $408,200 to $612,349 $612,350 or more

Ordinary income is of course taxed progressively, with the IRS taking a bigger bite from income in each successive tax bracket. It's possible, then, that a short-term capital gain, or part of it at least, might be taxed at a higher rate than your regular earnings, if it causes your overall income to jump into a higher tax bracket.

Let's use the case above as an example. Assuming you filed that income using the single status, you'd be in the 22% tax bracket with your regular earnings. (Actually, since the federal tax system is progressive, the first $9,700 you earn would be taxed at 10%, your income from $9,701 up to $39,475 would taxed at 12%, and only the income from $39,475 to $80,000 would be taxed at 22%.) Part of your $5,000 capital gain—the portion up to the $82,199 limit for the bracket—would be taxed at 22%. The remaining $2,801 of the gain, however, would be taxed at 24%, the rate for the next highest tax bracket.

Capital Gains Special Rates and Exceptions

Some assets receive different capital-gains treatment than the rates indicated above. Sometimes, too, the timeframe departs from the customary less-than-a-year or more-than-a-year benchmarks for short-and long-term capital gains.

Collectibles

If you sell art, antiques, jewelry, precious metals, stamp collections, and other collectibles, you're taxed at a 28% rate on your gains, regardless of your income. So if you're in a lower bracket than 28%, you'll be levied at this higher tax rate, while if you're in a tax bracket with a higher rate, your capital gains tax will be limited to the 28% rate.

Owner-Occupied Real Estate

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 a home are 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 years or more. However, you don't get a break should you sell the home for less than you paid for it; capital losses from the sale of personal property, such as a home, are not deductible from gains.

Here's how it can work. A single taxpayer who purchased a house for $300,000 and later sells it for $700,000 made a $400,000 profit on the sale. After applying the $250,000 exemption, he must report a capital gain of $150,000, which 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, thus reducing even more the amount of taxable capital gain. So if our owner spent, for example, $50,000 on a new kitchen while owning the house, he might, for the purposes of computing capital gains, be able to add that expenditure to the $300,000 original purchase price. That 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

When investors own real estate, they're often allowed to take depreciation deductions against income to reflect the steady deterioration of the property as it ages. (By the way, don't confuse this decline in the home's condition with a possible appreciation in the value of the entire property, driven by the real-estate market. They're separate figures.)

The deduction for depreciation essentially reduces the amount you're considered to have paid for the property in the first place. That in turn can increase your taxable capital gain if you sell it, because the gap between the property's value, with deductions made, and its sale price will be greater.

For example, if you paid $200,000 for a building and you're allowed to claim $5,000 in depreciation, you'll be treated subsequently as if you'd paid $195,000 for the building. If you then go on to 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 in the example above, if the person sold the building for $210,000, there would be total capital gains of $15,000, $5,000 of which would be treated as a recapture of the deduction from income. That recaptured amount is taxed at 25%, where the remaining $10,000 of capital gain would be taxed at one of the 0%, 15%, or 20% rates indicated above.

If you own real estate as an investment and are contemplating a sale, consider speaking with a tax professional about the 1031 exchange process. Rules and regulations apply, but a successful 1031 exchange may allow you to sell property and reinvest the proceeds into new real estate without paying capital gains or depreciation recapture taxes.

Investment Exceptions

If your income is high, you may be subject to another levy, known as the net investment income tax. This tax imposes an additional 3.8% of taxation on your investment income, including your capital gains, if your modified adjusted gross income (not your taxable income) exceeds certain maximums. Those threshold amounts are $250,000 if married and filing jointly, or a surviving spouse; $200,000 if you’re single or a head of household; and $125,000 if married, filing separately. 

The Advantages of Long-Term Over Short-Term Gains

Keeping for longer investments that will be subject to capital gains once they'e realized has at least two distinct pluses.

First, for many, if not most, people the tax bite will be lower from realizing a capital gain after more than a year, rather than within months. Let's say you bought 100 shares of XYZ stock at $20 per share and sold them at $50 per share; your regular income from earnings is $100,000 a year. Assuming that income, the chart below compares the taxes you'd pay if the gain was realized (and taxed for married couple filing jointly) after holding the stock for over a year compared with doing so in less than that time.

Transactions and consequences Long-term capital gain Short-term capital gain
Bought 100 shares @ $20 $2,000 $2,000
Sold 100 shares @ $50 $5,000 $5,000
Capital gain $3,000 $3,000
Capital gain  $450 (taxed @ 15%) $720 (taxed @24%)
Profit after tax $2,550 $2,280

By opting for a long investment gain, Uncle Sam is getting his hands on $450 of your profits, based on long-term capital gains rates. But had you held the stock for less than one year (and so 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 bite of 24%, the applicable rate for income over $84,200. That adds an additional $270 to the capital-gains tax bill, for a total of $720.

Then there's the fact that money diverted to taxes are funds for which you lose the opportunity to re-invest, and so continue to earn on. Sure, you may, as a savvy short-term investor, have the possibility to make a higher return by cashing in your investments frequently and repeatedly shifting the funds to fresh new opportunities. But even a higher return may not compensate for how much those regular short-term capital-gains tax bills eat away at your available investment nest egg.

To illustrate, we compared the 30-year impact (admittedly for a high-rolling couple who'd pay the highest long-term capital gains rate of 20%) of a $1,000 sum invested long-term versus in a series of short-term investments, each held for a little more than a year (to avoid the short-term tax bill that would kick in for an even- shorter investment). Even with the long-term investment earning 10% a year, versus 12% for each of the short-term investments, the long-run strategy would yield almost an additional $20,000 over 30 years than the "realize-and-reinvest" approach.

And that gap exists in spite our long-term trader earning a lower rate of return (10%, compared with 12% for the short-term trader. Had both investors been earning the same rate, the difference would be even more staggering. In fact, with a 10% rate of return, the short-term investor would have earned only $80,000 after taxes.

Making constant changes in investment holdings—resulting in high payments of capital gains tax and commissions—is called churning. Unscrupulous portfolio managers and brokers have been accused of churning, or excessively trading a client's account to increase commissions, even though it diminishes returns.

Gains are calculated on your basis in an asset—what you paid to acquire it, less depreciation, plus costs of sale and costs of any improvements you made. You inherit the donor's basis when an asset is given to you as a gift. The original basis transfers to you unless the asset is inherited. In this case, the basis is stepped up to its date-of-death value.

  • Short-term gains are taxed as regular income according to tax brackets up to 37% as of 2019.
  • Long-term gains are subject to special, more favorable tax rates of 0%, 15%, and 20%, also based on income.
  • One year of ownership is the deciding factor. Short-term gains result from selling property owned for one year or less