Short-term capital gains are taxed as ordinary income. Any income that you receive from investments that you held for one year or less must be included in your taxable income for that year. For example, if you have $90,000 in taxable income from your salary and $10,000 from short-term investments, then your total taxable income is $100,000.
The tax that you’ll pay on short-term capital gains follows the same tax brackets as ordinary income.
| Tax Rates for Short-Term Capital Gains 2023 | |||||||
|---|---|---|---|---|---|---|---|
| Filing Status | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
| Single | Up to $11,000 | $11,000+ to $44,725 | $44,725+ to $95,375 | $95,375+ to $182,100 | $182,100+ to $231,250 | $231,250+ to $578,125 | Over $578,125 |
| Head of household | Up to $15,700 | $15,700+ to $59,850 | $59,850+ to $95,350 | $95,350+ to $182,100 | $182,100+ to $231,250 | $231,250+ to $578,100 | Over$578,100 |
| Married filing jointly | Up to $22,000 | $22,000+ to $89,450 | $89,450+ to $190,750 | $190,750+ to $364,200 | $364,200+ to $462,500 | $462,500+ to $693,750 | Over $693,750 |
| Married filing separately | Up to $11,000 | $11,000+ to $44,725 | $44,725+ to $95,375 | $95,375+ to $182,100 | $182,100+ to $231,250 | $231,250+ to $346,875 | Over $346,875 |
Source: Internal Revenue Service
Ordinary income is taxed at rates that increase as your income increases. It’s possible that a short-term capital gain (or at least part of it) might be taxed at a higher rate than your regular earnings. That’s because it might cause part of your overall income to jump into a higher marginal tax bracket.
Let's use our above example of a $90,000 salary and $10,000 short-term capital gain. Given the 2023 federal income tax rates, and assuming you are filing as a single person, you would be in the 22% tax bracket. However, because of the progressive nature of the federal tax system, the first $11,000 that you earn would be taxed at 10%, your income from over $11,000 up to $44,725 would be taxed at 12%, and only the income from over $44,725 to $95,375 would be taxed at 22%.
Continuing with the example, the portion of your $10,000 short-term capital gain that can be allotted to the $95,375 limit for the bracket (given your $90,000 salary) is $5,375. That figure would be taxed at 22%. The remaining $4,625 of the gain, however, would be taxed at 24%, the rate for the next highest tax bracket.
Make sure you consult an accountant or other financial professional who can help guide you through the process if you have trouble understanding how capital gains affect your tax bracket and overall tax liability.
Capital Gains and State Taxes
Whether you also pay capital gains to the state depends on where you live. Some states also tax capital gains, while others have no capital gains taxes or favorable treatment of them. The following states have no income taxes and no capital gains taxes:
- Alaska
- Florida
- Nevada
- New Hampshire
- South Dakota
- Tennessee
- Texas
- Washington
- Wyoming
Several states offer either a credit, deduction, or exclusion. For example, Colorado offers an exclusion on real or tangible property, and New Mexico offers a deduction on federally taxable gains. Montana has a credit to offset part of any capital gains tax. Washington state implemented a 7% tax on long-term net capital gains in excess of $250,000 beginning Jan. 1, 2022.
Which Assets Are Counted as Capital Gains?
Some assets receive different capital gains treatment or have different time frames than the rates indicated above.
Collectibles
You’re taxed at a 28% rate—regardless of your income—for gains on art, antiques, jewelry, precious metals, stamp collections, coins, and other collectibles.
Qualified Small Business Stock
The tax treatment of a qualified small business (QSB) stock dependson when the stock was acquired, by whom, and how long it was held. To qualify for this exemption, the stock must have been acquired from a QSB after Aug. 10, 1993, and the investor must be a noncorporate entity that held the stock for at least five years.
A QSB is generally defined as a domestic C corporation with aggregate gross assets that have never exceeded $50 million at any point since Aug. 10, 1993. Aggregate gross assets include the amount of cash held by the company, as well as the adjusted bases of all other property owned by the corporation. Additionally, the QSB must file all required reports.
Only certain types of companies fall under the category of a QSB. Firms in the technology, retail, wholesale, and manufacturingsectorsare eligible as QSBs, while those in the hospitality industry, personal services,financial sector, farming, and mining are not.
This exemption originally allowed the taxpayer to exclude 50% of any gain from the sale of QSB stock. However, it was later increased to 75% for QSB stock acquired from Feb. 18, 2009, to Sept. 27, 2010, and then to 100% for QSB stock acquired after Sept. 27, 2010. The gain that is eligible for this treatment has a cap of $10 million, or 10 times theadjusted basisof the stock—whichever is greater.
Home Sale Exclusion
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 your principal residence is 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 of the five years leading up to the sale. If you sold your home for less than you paid for it, this loss is not considered tax deductible, because capital losses from the sale of personal property, including your home, are not tax deductible.
For example, a single taxpayer who purchased a house for $300,000 and sold it for $700,000 made a $400,000 profit on the sale. After they apply the $250,000 exemption, they must report a capital gain of $150,000. This 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. These can serve to further reduce the amount of taxable capital gain. If you spent $50,000 to add a new kitchen to your home, this amount could then be added to the $300,000 original purchase price. This 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
Investors who own real estate are often allowed to apply deductions to their total taxable income based on the depreciation of their real estate investments. This deduction is meant to reflect the steady deterioration of the property as it ages, and it essentially reduces the amount that you’re considered to have paid for the property in the first place. This also has the effect of increasing your taxable capital gain when the property is sold.
For example, if you paid $200,000 for a building and are allowed to claim $5,000 in depreciation, then you’ll be treated subsequently as if you had paid $195,000 for the building. If you then sell the real estate, the $5,000 is treated asrecapturing those depreciation deductions. The tax rate that applies to the recaptured amount is 25%.
So if you sold the building for $210,000, there would be total capital gains of $15,000. But $5,000 of that figure would be treated as a recapture of the deduction from income. That recaptured amount is taxed as ordinary income but is capped at the maximum rate of 25%. The remaining $10,000 of capital gain would be taxed at one of the 0%, 15%, or 20% rates indicated above.
Investment Exceptions
High-income earners may be subject to another tax on their capital gains: the net investment income tax. This tax imposes an additional 3.8% on your investment income, including your capital gains if your modified adjusted gross income (MAGI) exceeds certain maximums: $250,000 if married and filing jointly or you’re a surviving spouse, $200,000 if you’re single or a head of household, and $125,000 if married and filing separately.
Advantages of Long-Term Capital Gains
It can be advantageous to keep investments longer if they will be subject to a capital gains tax once they’re realized.
The tax rate will be lower for most people if they realize a capital gain after one year. For example, suppose you bought 100 shares of XYZ Corp. stock at $20 per share and sold them at $50 per share. Your regular income from earnings is $100,000 a year, and you file taxes jointly with your spouse. The chart below compares the taxes that you would pay when you sold the stock after more than a year vs. after less than a year.
| How Patience Can Pay off in Lower Taxes | ||
|---|---|---|
| Transactions and consequences | Long-term capital gain | Short-term capital gain |
| Bought 100 shares at $20 | $2,000 | $2,000 |
| Sold 100 shares at $50 | $5,000 | $5,000 |
| Capital gain | $3,000 | $3,000 |
| Capital gainstax | $450 (taxed at 15%) | $660(taxed at 22%) |
| Profit after tax | $2,550 | $2,340 |
*This chart shows how a married couple filing jointly earning $100,000 a year could avoid more than $200 in taxes by waiting over one year before selling shares that had appreciated $3,000.
You would pay $450 of your profits by opting for a long-term investment gain and being taxed at the long-term capital gains rate. But had you held the stock for one year or less (and hence incurred a short-term capital gain), your profit would have been taxed at yourordinary incometax rate. For our $100,000-a-year couple, that would trigger a tax rate of 22%, the applicable rate for income over $89,450 in 2023. That adds an additional $210 to the capital gains tax bill, for a total of $660.
While it’s possible to make a higher return by cashing in your investments frequently and repeatedly shifting the funds to fresh new investment opportunities, that higher return may not compensate for higher short-term capital gains tax bills. Making constant changes in investment holdings, resulting in high payments of capital gains tax and commissions, is called churning when it's done by a broker.
Frequently Asked Questions
Did Long-Term Capital Gains Rates Go up in 2022?
Capital gains did not go up in 2022, despite proposals to change legislation. In September 2021, the U.S. House Ways and Means Committee released its proposal of tax-raising provisions. The proposal included an increase from 20% to 25% for the top long-term capital gains rate. The proposal was written to be effective as of Sept. 13, 2021, which meant that transactions completed before that date would still be subject to the 20% rate, while transactions afterward would be subject to 25%.
How Do I Calculate Capital Gain on the Sale of Property?
You must first determine your basis in the property. Your basis is your original purchase price plus any fees that you paid minus any depreciation taken. Next, determine your realized amount. Your realized amount is the price that you’re selling the property for minus any fees paid by you. Finally, you need to subtract your basis from your realized amount. If the figure is positive, then you will have a capital gain. If the figure is negative, then you will have a capital loss.
Will My Long-Term Capital Gains Push Me Into a Higher Ordinary Income Tax Bracket?
Your long-term capital gains will not cause your ordinary income to be taxed at a higher rate. Ordinary income is calculated separately and taxed at ordinary income rates. More long-term capital gains may push your long-term capital gains into a higher tax bracket (0%, 15%, or 20%), but they will not affect your ordinary income tax bracket.
However, if you had short-term capital gains, then they would increase your ordinary income and potentially push you into the next marginal ordinary income tax bracket.
The Bottom Line
The tax on a long-term capital gain is almost always lower than if the same asset were sold in a year or less. Most taxpayers don’t have to pay the highest long-term rate. Tax policy encourages you to hold assets subject to capital gains for more than a year.
As a financial expert with a deep understanding of taxation and investment, let's delve into the concepts presented in the article on short-term capital gains and their taxation implications.
Short-Term Capital Gains Taxation: The article correctly points out that short-term capital gains, referring to profits from investments held for one year or less, are taxed as ordinary income. The tax rates for short-term capital gains align with the ordinary income tax brackets. The provided 2023 tax brackets for different filing statuses, ranging from 10% to 37%, illustrate how different levels of income are taxed at varying rates.
Tax Calculation Example: An illustrative example demonstrates how short-term capital gains can affect your overall tax liability. The article presents a scenario where a taxpayer has a $90,000 salary and $10,000 in short-term capital gains. The progressive nature of the tax system means that portions of the income are taxed at different rates within the applicable brackets, showcasing the intricate relationship between income and taxation.
State Taxes on Capital Gains: The article rightly highlights that state taxes on capital gains vary, with some states not imposing any income or capital gains taxes. Others may offer credits, deductions, or exclusions to mitigate the impact of capital gains taxes. The listed states with no income taxes and no capital gains taxes provide a useful reference.
Special Cases and Exemptions: The article introduces various assets that receive different capital gains treatment. Notable examples include collectibles, which are taxed at a fixed rate of 28%, and qualified small business stock, subject to specific conditions and exemptions that can lead to reduced tax rates.
Home Sale Exclusion: Homeowners benefit from a special capital gains arrangement when selling their principal residence. The first $250,000 ($500,000 for joint filers) of capital gains is excluded from taxable income, provided certain criteria are met. The article emphasizes that capital losses from the sale of personal property, including homes, are not tax-deductible.
Investment Real Estate: Investors in real estate can apply deductions based on property depreciation, which reduces the property's initial cost. The depreciation deductions, when recaptured upon selling the property, are taxed at a specific rate (25%). This section sheds light on the complexity of calculating taxable capital gains in the context of real estate investments.
Net Investment Income Tax: High-income earners may be subject to an additional tax, the net investment income tax, imposing a 3.8% surcharge on investment income, including capital gains, if certain income thresholds are exceeded.
Advantages of Long-Term Capital Gains: The article stresses the advantages of holding investments for more than one year, leading to lower long-term capital gains tax rates compared to short-term rates. A practical example illustrates how patience in holding assets can result in significant tax savings.
FAQs: The article addresses common questions, including whether long-term capital gains rates changed in 2022, how to calculate capital gains on property sales, and the impact of long-term capital gains on ordinary income tax brackets.
Conclusion: In conclusion, the article provides a comprehensive overview of short-term capital gains taxation, considering federal and state levels, special cases, exemptions, and the advantages of long-term investments. The inclusion of examples and FAQs enhances the clarity and applicability of the information presented.
