Long-term capital gains are taxed at lower rates than ordinary income, not the same rate

When you sell an investment you've held for more than one year, the profit is taxed as a long-term capital gain, not as ordinary income. The tax rate depends on your total income for the year and ranges from 0% to 20% — significantly lower than ordinary income tax brackets, which go up to 37%. This is a real difference in what you owe.

The IRS separates long-term gains into three rate brackets. Your income level determines which bracket applies to you, not the amount of the gain itself. A person in the highest ordinary income bracket might still pay only 20% on long-term gains, while someone in a lower ordinary bracket might pay 15% or even 0%.

Short-term capital gains — profits from investments held one year or less — are taxed as ordinary income at your full tax rate. This distinction matters because holding an investment just a few extra months can cut your tax bill significantly.

Key Takeaways

  • Long-term capital gains use three separate tax rates (0%, 15%, or 20%) based on your income level, while ordinary income uses seven brackets that go up to 37%.
  • You must hold an investment for more than one year for the gain to may have access to as long-term; one day short of that and it is taxed as ordinary income.
  • The date that matters is when you bought the investment and when you sold it — the holding period is measured from purchase date to sale date.
  • Long-term capital gains rates apply only to the profit, not to the original amount you invested.
  • State income tax still applies to long-term capital gains in most states, so your total tax burden includes both federal and state rates.

The three long-term capital gains tax rates and income thresholds

The IRS uses income thresholds to place you in one of three long-term capital gains brackets. These thresholds change each year and depend on your filing status — single, married filing jointly, married filing separately, or head of household.

The 0% rate applies to the lowest earners. For 2024, this covers single filers with taxable income up to $47,025 and married couples filing jointly up to $94,050. If your long-term gains fall within this bracket, you owe no federal tax on them.

The 15% rate is the middle bracket and covers most people who sell investments. For 2024, it applies to single filers earning $47,025 to $518,900 and married couples filing jointly earning $94,050 to $583,750.

The 20% rate applies to high earners. For 2024, single filers above $518,900 and married couples above $583,750 pay this rate on long-term gains. These thresholds adjust annually for inflation, so the numbers change each year.

How the one-year holding period works

The holding period is measured from the date you purchased the investment to the date you sold it. If you bought stock on March 15, 2023, and sold it on March 15, 2024, you held it for exactly one year — and the gain qualifies as long-term. If you sold it on March 14, 2024, it would be short-term.

The IRS counts the purchase date as day zero. The holding period begins the day after you buy. So if you purchase on January 1, the one-year mark is January 2 of the following year.

This rule applies to all types of investments: stocks, bonds, mutual funds, real estate, and cryptocurrency. The type of asset does not matter — only how long you held it.

What happens if you sell before one year

Short-term capital gains are taxed at your ordinary income tax rate. If you are in the 24% ordinary income bracket and sell an investment after holding it for six months, the entire gain is taxed at 24%, not at the 15% long-term rate.

This can make a real difference. A $10,000 gain taxed as short-term at 24% costs $2,400 in federal tax. The same $10,000 gain taxed as long-term at 15% costs $1,500. The difference is $900 on a single transaction.

Some investors deliberately hold investments longer to reach the one-year mark, even if they would otherwise sell earlier. The tax savings can outweigh the cost of waiting, depending on your circumstances and the investment's performance.

How long-term capital gains interact with your ordinary income

Your long-term capital gains are stacked on top of your ordinary income to determine which tax bracket applies. If you earn $50,000 in wages and have $30,000 in long-term gains, your total taxable income is $80,000 for purposes of determining your long-term capital gains rate.

This stacking can push you into a higher capital gains bracket. If you are single and earn $40,000 in wages, you are in the 0% long-term capital gains bracket. But if you also have $20,000 in long-term gains, your total income is $60,000, which puts you in the 15% bracket for at least part of those gains.

The order of stacking matters. Ordinary income is counted first, then long-term capital gains are added on top. This means your capital gains may be split across two brackets if they straddle the threshold.

State income tax on long-term capital gains

Most states tax long-term capital gains as ordinary income at the state level, even though the federal rate is lower. Your state tax rate applies to the full gain, regardless of the federal long-term rate you pay.

A few states have no income tax at all — Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming. If you live in one of these states, you pay only the federal long-term capital gains rate.

California, New Jersey, and a few others tax long-term capital gains at rates that can exceed 10% at the state level. When you add state and federal taxes together, your total tax on a long-term gain can still be significantly lower than if the gain were taxed as ordinary income, but the state portion is real.

Frequently Asked Questions

Do I have to hold an investment for exactly one year, or is 12 months enough?

You need to hold it for more than one year. If you buy on January 1, 2024, and sell on January 1, 2025, you have held it for exactly one year, and the gain is short-term. You must sell on January 2, 2025, or later for it to be long-term. The IRS counts the purchase date as day zero and begins the holding period on day one.

What if I inherit stock from someone — does the holding period start when they bought it?

No. When you inherit an investment, you receive a "stepped-up basis" to its value on the date of death. Any gain you have is measured from that date forward. If you sell the inherited stock immediately, you owe no capital gains tax because there is no gain yet. The holding period for long-term treatment starts the day after you inherit it.

Can I use long-term capital gains losses to offset ordinary income?

Capital losses (both long-term and short-term) can offset capital gains first. If you have more losses than gains, you can deduct up to $3,000 of the excess loss against ordinary income in a single year. Any remaining losses carry forward to future years. This is true whether the losses are long-term or short-term.

If I sell mutual fund shares, does the holding period apply to each share separately?

Yes. If you own shares in the same mutual fund purchased at different times, each lot has its own holding period. When you sell, you can specify which shares you are selling — those held more than one year are taxed as long-term, and those held less are short-term. If you do not specify, the IRS assumes you sold the oldest shares first (first-in, first-out).

Does the long-term capital gains rate apply to dividends?

may have access to dividends are taxed at the same rates as long-term capital gains (0%, 15%, or 20%), but they are not capital gains. Ordinary dividends are taxed as ordinary income. Most dividends from U.S. corporations and certain foreign corporations are may have access to if you held the stock for at least 60 days around the dividend date. Check your brokerage statement to see which dividends are may have access to.