What capital gains tax is and who pays it

Capital gains tax is a tax on profit you make when you sell something you own — a house, stock, business, or other asset — for more than you paid for it. The difference between what you paid and what you sold it for is your gain, and that gain is taxable income.

You only owe capital gains tax if you actually sell the asset. If you own stock worth twice what you paid but never sell it, you owe nothing. The tax applies whether you're an individual, a business owner, or an investor. The IRS taxes capital gains at the federal level, and most states tax them too.

The amount you pay depends on two things: how long you held the asset before selling it, and your total income for the year. A person in a higher income bracket pays a higher rate on the same gain than someone earning less.

Key Takeaways

  • Long-term capital gains (assets held over one year) are taxed at lower rates than short-term gains, which are taxed as ordinary income.
  • Federal long-term capital gains rates are 0%, 15%, or 20%, depending on your income; short-term gains use your regular income tax bracket.
  • Your state may also tax capital gains, and the rate varies by state — some have no capital gains tax at all.
  • You report capital gains on your tax return using Form 8949 and Schedule D, and you must report the sale price and your original cost basis.
  • Losses on asset sales can reduce your capital gains tax, and unused losses can carry forward to future years.

Long-term versus short-term capital gains rates

The IRS treats gains differently based on how long you owned the asset. If you held it for more than one year, it's a long-term capital gain and gets a lower tax rate. If you held it for one year or less, it's a short-term capital gain and is taxed as ordinary income — meaning it uses your regular income tax bracket, which is higher.

Federal long-term capital gains rates are 0%, 15%, or 20%. Which rate you pay depends on your filing status and total taxable income for the year. For example, a single filer in 2024 pays 0% on long-term gains up to $47,025 of income, 15% from $47,026 to $518,900, and 20% above that. These income thresholds change each year.

Short-term gains are taxed at your ordinary income tax rate, which ranges from 10% to 37% depending on your bracket. This is why holding an asset longer than one year usually saves you money in federal tax.

State capital gains taxes

Most states tax capital gains as part of your regular income tax. A few states — including Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming — have no income tax at all, so they don't tax capital gains. Other states tax capital gains at their regular income tax rate, which varies widely.

California, for example, taxes long-term and short-term capital gains the same way it taxes ordinary income, with rates up to 13.3%. New York taxes capital gains as regular income, with rates up to 10.9%. Some states have special rates or exemptions for certain types of gains, like gains on the sale of a primary home.

When you sell an asset, you owe both federal and state tax on the gain (unless your state has no income tax). The total tax you pay is the sum of both.

How to calculate your capital gain

Your capital gain is the sale price minus what you originally paid for the asset, minus any costs directly tied to the sale or improvement. The amount you originally paid is called your cost basis.

If you bought stock for $5,000 and sold it for $8,000, your gain is $3,000. If you bought a rental property for $200,000, spent $50,000 on improvements, and sold it for $300,000, your gain is $50,000 (the sale price minus the cost basis of $250,000). Selling costs like real estate commissions or broker fees reduce your gain.

Inherited assets get a "step-up" in basis, meaning your cost basis becomes the asset's value on the date of death, not what the previous owner paid. This can significantly reduce or eliminate capital gains tax on inherited property sold shortly after inheritance.

How to report capital gains on your tax return

You report capital gains using Form 8949 (Sales of Capital Assets) and Schedule D (Capital Gains and Losses). Form 8949 lists each asset you sold — the date you bought it, the date you sold it, your cost basis, the sale price, and your gain or loss. Schedule D summarizes your long-term and short-term gains and losses and calculates your net capital gain.

You must report the sale even if you had a loss. Capital losses can reduce your capital gains, and if your losses exceed your gains, you can deduct up to $3,000 of the net loss against other income in that year. Any unused loss carries forward to future years.

Your broker or investment firm will send you a Form 1099-B (Proceeds from Broker and Barter Exchange Transactions) showing sales of stocks, bonds, and other securities. For real estate, you may receive a Form 1099-S (Proceeds from Real Estate Transactions). These forms go to the IRS, so your reported gains must match.

Special rules for home sales

If you sell your primary residence, you may be able to exclude up to $250,000 of gain from tax (or $500,000 if you're married filing jointly). You must have owned and lived in the home for at least two of the five years before the sale. This exclusion is available once every two years.

If your gain exceeds the exclusion amount, you owe tax on the excess. If you sell a second home, investment property, or rental property, the full gain is taxable — the home sale exclusion does not apply.

Using losses to reduce capital gains tax

If you sell an asset at a loss, you can use that loss to reduce capital gains from other sales in the same year. If you have $10,000 in gains and $4,000 in losses, your net gain is $6,000, and you pay tax on $6,000 instead.

If your losses exceed your gains, you can deduct up to $3,000 of the net loss against wages, interest, or other ordinary income. If you have more than $3,000 in unused losses, they carry forward to the next year and the year after, with no time limit. This can be useful if you have a large loss in one year but smaller gains in future years.

There is one restriction: the wash-sale rule. If you sell a security at a loss and buy the same or a substantially identical security within 30 days before or after the sale, the loss is disallowed. The loss is added to the cost basis of the new purchase instead.

Frequently Asked Questions

Do I owe capital gains tax if I inherited an asset and sold it?

Inherited assets receive a step-up in basis to their value on the date of death. If you inherited stock worth $10,000 and sold it for $10,500 a few months later, your gain is only $500, not the gain the previous owner would have had. If you sell it for less than its value at death, you may owe no tax at all.

What if I sold an asset at a loss?

Report the loss on Form 8949 and Schedule D. You can use it to reduce capital gains from other sales in the same year. If losses exceed gains, you can deduct up to $3,000 against other income. Unused losses carry forward to future years with no expiration date.

Do I have to report a capital gain if it's under a certain amount?

Yes. The IRS requires you to report all capital gains, no matter how small. Your broker sends Form 1099-B to the IRS, so the sale is already reported. Failing to report it on your tax return creates a mismatch that can trigger an audit.

How do I know if my gain is long-term or short-term?

Count the days from the date you bought the asset to the date you sold it. If it's more than one year, it's long-term. The IRS counts the purchase date as day zero and the sale date as day one, so holding from January 1 to January 2 of the next year is long-term.

Can I reduce my capital gains by donating the asset to charity instead of selling it?

Yes. If you donate appreciated stock or property to a may have access to charity, you avoid the capital gains tax entirely and can deduct the fair market value of the asset as a charitable contribution. This is often more tax-efficient than selling and donating the proceeds.