Short-Term Capital Gains: Definition, Calculation, and Rates

What Is a Short-Term Gain?

A short-term gain is a profit realized from the sale of personal or investment property, a capital asset, that has been held for one year or less. These gains are taxed as ordinary income, which is your personal income tax rate.

Key Takeaways

• A short-term gain is a profit realized from the sale of personal or investment property that has been held for one year or less.
• The amount of the short-term gain is the difference between the basis of the capital asset, the purchase price, and the sale price received.
• Short-term gains are taxed at the taxpayer's top marginal tax rate or regular income tax bracket, which can range from 10% to 37%.
• Short-term capital gains receive less preferential tax treatment compared to assets held for at least one year taxed at lower long-term capital gain rates.
• Investors can avoid capital gain taxes by holding onto assets for longer periods, donating assets to nonprofits, offsetting gains and losses, and leveraging retirement accounts.

Understanding Short-Term Gains

The amount of the short-term gain is the difference between the basis of the capital asset and the sale price received for selling it. Short-term gains are taxed at the taxpayer's top marginal tax rate. The 2022 and 2023 regular income tax brackets range from 10% to as high as 37%, depending on the investor's annual income.

A short-term gain can only be reduced by a short-term loss. A taxable capital loss is limited to \$3,000 for single taxpayers and \$1,500 for married taxpayers filing separately. Any excess capital losses above \$3,000 can be carried forward to offset ordinary taxable income in later years until fully utilized. Short-term gains and losses are netted against each other.

If a taxpayer purchased and sold two different securities during the tax year such as Security A and Security B, and the investor has earned a gain on Security A of \$5,000 and a loss on Security B of \$3,000, the net short-term gain is \$2,000 (\$5,000 - \$3,000).

To properly identify short-term vs. long-term assets and taxable amounts, maintain records of purchase dates and purchase prices.

Short-Term Capital Gain Formula and Calculation

Short-term capital gains are calculated by taking the difference between two figures: the acquisition basis of an asset and the disposition basis of an asset. This difference is then assessed by the taxpayer's specific marginal tax rate.

Short-Term Capital Gain = (Disposition Basis - Acquisition Basis) * Tax Rate

Acquisition Basis

It is most advantageous for taxpayers to have a higher acquisition basis as this reduces the taxable base of a disposition. The acquisition basis of an asset is outlined in Topic No. 703 from the IRS which identifies the basis of an asset as the cost to you. This may be paid in cash, debt obligations, other property, or services. This cost is inclusive of sales taxes.

There are special considerations for assets not directly purchased and specific rules apply to the asset basis and related short-term capital gain tax for gifts or inherited property. The acquisition basis of stocks and bonds is inclusive of any commissions, transfer fees, or additional costs to facilitate the purchase.

Disposition Basis

The disposition basis of an asset may be as simple as the amount of money you received in exchange for the good. If you sell shares of stock for \$100/each, your disposition basis will likely be \$100/share. Alternatively, you may exchange an asset for a service or asset that does not have an active marketplace.

In general, the value of the disposition is the cost or value of the assets acquired. For some dispositions, taxpayers may receive Form 1099 detailing the value of the transaction. Be mindful that the total amount paid by the buyer may not equal the basis for the seller as the seller may not be entitled to all proceeds due to fees or third-party commissions.

Short-Term Capital Gains and IRAs

Investors who earned short-term gains from an investment that was in an individual retirement account (IRA) do not have to pay any short-term capital gains taxes on that income. However, if an investor takes out any money from the IRA, the withdrawal amount is considered income and is taxed at the investor's or taxpayer's ordinary income tax rate.

The benefit of IRAs is that investors can grow their investments over the years without paying any capital gains taxes. Although the taxes on the gains are deferred, once the money is withdrawn, it's taxed at the current income tax rate for that investor.

Rebalancing one's portfolio entails selling securities to ensure the right asset allocation or weight across asset classes is achieved. When performed in a retirement account, rebalancing is not a taxable event and will not result in short-term capital gains.

Short-Term Capital Gains and Taxes

Form 8949 (Sales and Other Dispositions of Capital Assets) is a form from the IRS to report gains and losses from investments. The form has instructions to guide you on how to calculate and report short-term gains.

The upper portion of the form asks for the taxpayer's information such as name and social security number. The tax form also has two sections to be completed. The first section is for short-term gains, and the second section is for any long-term investment gains.

Typically, the IRS form Schedule D, Capital Gains, and Losses would be used to report capital gains and losses. However, Form 8949 may also need to be completed outlining the net gain or losses so that the subtotals from this form can be carried over to the Schedule D form.

The total from the gain is added to your income for the year. As a result, you could pay a higher tax on your short-term gain from your investment if it pushed your income into a higher tax bracket than your ordinary income. It's important to consult a tax professional before filing taxes on your short-term capital gains.

2023 Short-Term Capital Gains Tax Rates

Short-term capital gains are taxed at the taxpayer's marginal tax rate and depend on the investor's federal income tax bracket:

Source: Internal Revenue Service

Short-Term vs. Long-Term Capital Gains

Capital gains come in two variations: short-term and long-term. Short-term capital gains are imposed on assets held for one year or less. Conversely, long-term capital gains are taxed at a capital gains rate, which is often lower than a person's marginal tax rate. Long-term gains are the profits from an investment that's held for more than one year.

Long-term capital gains receive favorable tax rates to encourage investors to increase the holding period of their assets. For this reason, carefully documenting your acquisition date is just as important as understanding your purchase price.

Capital gains are imposed on the amount of profit, but the actual assessed rate is determined by the number of days the asset was held for. By comparison, it is more favorable to hold an asset long-term compared to short-term for tax purposes. 2023 long-term rates are below.

Exceptions to Short-Term Capital Gains

Some assets receive favorable or less favorable short-term capital gain treatment depending on the nature of the asset. These rules have been enacted to provide tax benefits for some taxpayers or produce heavier tax burdens for others.

• Although collectibles are taxed at a higher-than-normal long-term capital rate, collectibles are usually imposed capital gains taxes based on the taxpayer's ordinary income tax rates. There are no special short-term capital gains rates for collectibles.
• Qualified small business stock may receive an exemption if the stock was acquired after a specific date and held for at least five years. That company must have never exceeded \$50 million of gross assets.
• Home sales may receive favorable capital gain treatment for homeowners who lived in the home for at least two of the five years leading up to the sale. Due to the period length of the exemption requirement, this exemption does not pertain to short-term capital gains.
• Capital gains from real estate investments may include the recapture of depreciation. The recapture amount of depreciation is often taxed at a maximum rate of 25% with the non-recapture amount taxed at the prevailing capital gains rate.

For any situation above, consult a tax advisor about the full tax treatment regarding calculating your asset's basis, exemption status, and short-term capital gains rate.

How to Minimize Capital Gains Taxes

Increase Holding Periods

Hold onto assets for more than a year to take advantage of long-term capital gains tax rates, which are typically lower than short-term rates. Whenever possible, try not to liquidate an asset that has been held for less than a year, as that often maximizes the tax rate paid on that asset.

Leverage Tax Efficient Accounts

Use tax-advantaged accounts, such as IRAs or 401(k)s, to defer taxes on capital gains until withdrawal. If capital assets are bought, held, or sold in non-efficient accounts, taxes may be immediately due. Instead, these types of retirement accounts may deflect when taxes need to be paid or reduce the taxes to be paid.

Leverage Tax Offset Strategies

Taxpayers can offset capital gains with capital losses from selling losing investments. Though there are limits to what can be sold and offset (and limits on what can then be repurchased to avoid a wash sale), taxpayers can maximize the benefits they receive by making the most of their losses. There are limits to carrying losses forward, and there are limits to what losses can be net against gains.

Donate Wisely

Taxpayers can donate appreciated assets to charity instead of selling and realizing the gains. When assets are donated, the taxpayer is not assessed gains on a transaction; instead, they receive a donation receipt for the fair market value of their donation. The nonprofit also is not assessed any tax penalty due to its tax-exempt status.

Short-Term Capital Gains and Wash Sales

Investors engaging in short-term trading are at higher risk to be engaged in wash-sales, transactions in which an individual sells a security and re-purchases the same security within 60 days. If the individual buys the same stock that quickly after selling it, the IRS disallows any loss to be recognized on the original sale. Wash sales are also directly related to short-term capital gains as the potential loss would be added to the new cost basis.

Consider an example where an investor buys one share of stock for \$20, sells the share of stock for \$18 after one week, then re-buys the share of stock for \$19 two weeks later. The original loss of \$2 (\$20 - \$18) would be disallowed by the IRS. Instead, this loss is added to the new cost basis of the stock and means any potential short-term capital gain on the sale of the currently held stock is calculated on the cost basis of \$21 (\$19 purchase price + \$2 disallowed loss).

How Much of Short-Term Capital Gain Is Tax-Free?

The tax-free portion of an asset disposition held for a short period will depend on the taxpayer's ordinary income tax rate. Investors may be imposed taxes between 10% and 37% depending on their income and tax filing status. Unlike long-term capital gains, no portion of short-term capital gains is tax-free.

What Is the Short-Term Capital Gains Tax Rate for 2023?

Short-term capital gain rates are the same as ordinary tax rates for 2023. This means the lowest income taxpayers will pay 10% short-term capital gains tax rates, and the highest income taxpayers will pay 37% short-term capital gains tax rates. A full table of rates based on filing status and income is provided above.

How Do I Avoid Short-Term Capital Gains Tax?

The easiest way to avoid short-term capital gains taxes is to hold the asset longer; if possible, holding the asset for at least one year leaves taxpayers with much more favorable tax rates. In addition, short-term capital gains taxes can be minimized by ensuring the acquisition basis is maximized (i.e. includes certain taxes, fees, or commissions) while the disposition basis is minimized.

What Is the Difference Between Short-Term and Long-Term Capital Gains?

Short-term capital gains are imposed on assets held for less than one year. Should a taxpayer hold an asset for longer than one year, almost all capital gains are taxed at a more favorable rate. The only difference between these two capital gains is the period of ownership; this difference dictates different rates that are assessed on gains.

The Bottom Line

Assets disposed of within a year are often assessed as short-term capital gains taxes. Short-term capital gains are taxed at ordinary income tax rates and receive less favorable treatment than long-term assets (assets held for at least one year). There are no tax-free short-term capital gain rates; taxpayers with the lowest income will still be assessed 10% tax rates on short-term capital gains in 2023.

Article Sources
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