What Long-Term Capital Gains Tax Is

Long-term capital gains tax is the tax you owe when you sell an investment or asset you've held for more than one year and it has increased in value. The difference between what you paid for it and what you sold it for is your gain, and that gain is taxable income. The key word is "long-term"—hold the asset for over a year, and the tax rate is lower than if you sold it sooner.

The federal government taxes long-term capital gains at three different rates depending on your income level: 0%, 15%, or 20%. These rates are much lower than the ordinary income tax rates that explore to wages, interest, or short-term gains. Most people fall into the 15% bracket. Your state may also tax capital gains, though the rules vary widely by location.

Key Takeaways

  • You owe long-term capital gains tax only when you sell an asset you've held longer than one year and it's worth more than you paid for it.
  • Federal long-term capital gains rates are 0%, 15%, or 20% depending on your total income, which is much lower than ordinary income tax rates.
  • If you sell an asset within one year of buying it, you pay ordinary income tax rates on the gain instead, which can be significantly higher.
  • Your state may impose its own capital gains tax on top of federal tax, and some states have no capital gains tax at all.
  • The IRS requires you to report the sale on your tax return, and your broker will send you a Form 1099-B documenting the transaction.

How the One-Year Holding Period Changes Your Tax Bill

The difference between holding an asset just under one year and just over one year can save you thousands of dollars in taxes. If you sell within one year, your gain is treated as short-term capital gains and taxed at your ordinary income tax rate—which ranges from 10% to 37% depending on your income bracket. If you hold for more than one year, you get the preferential long-term rate instead.

For example, if you bought stock for $10,000 and sold it for $15,000 after eleven months, your $5,000 gain would be taxed at your ordinary rate. If you waited one month longer and sold at the same price, that same $5,000 gain would be taxed at the long-term rate of 0%, 15%, or 20%. The IRS counts the holding period from the day after you buy to the day you sell.

The Three Federal Tax Rates and Which One Applies to You

Your long-term capital gains rate depends on your taxable income for the year, not on how much the asset gained. The IRS sets income thresholds that change each year. For 2024, the 0% rate applies to single filers with taxable income up to $47,025, the 15% rate applies to income between $47,026 and $518,900, and the 20% rate applies to income above that. These thresholds are higher for married couples filing jointly and different for other filing statuses.

Your taxable income includes wages, interest, dividends, and capital gains all added together. If you have a large capital gain that pushes you into a higher bracket, part of your gain may be taxed at 15% and part at 20%. This is why some people time the sale of assets across two tax years—to keep their total income below a threshold and pay a lower rate.

State Capital Gains Taxes

Nine states have a separate capital gains tax on top of federal tax: California, Connecticut, Delaware, Illinois, Maryland, Minnesota, New Jersey, New York, and Washington. Most of these states tax capital gains at a flat rate between 5% and 13.3%, though the rules and thresholds vary. Some states only tax gains above a certain amount, and some exclude certain types of assets like primary residences.

Twenty-seven states have no capital gains tax at all. The remaining states tax capital gains as ordinary income, which means your gain is added to your wages and taxed at your state income tax rate. If you live in a state with no capital gains tax and sell an asset there, you still owe federal tax, but you avoid the state layer entirely.

What Counts as a Capital Asset and What Doesn't

Most things you buy and sell can trigger capital gains tax: stocks, bonds, mutual funds, real estate, cryptocurrency, collectibles, and business equipment. Your primary residence is partially exempt—you can exclude up to $250,000 of gain if you're single or $500,000 if you're married filing jointly, as long as you owned and lived in the home for at least two of the last five years.

Some assets don't generate capital gains tax at all. Gains on may have access to small business stock held for more than five years may be partially or fully excluded. Inherited assets get a "step-up in basis," meaning the cost basis resets to the value on the date of death, so heirs owe no tax on gains that occurred before they inherited it. Donations to charity are not taxable events, though you may be able to deduct the fair market value of the donation.

How to Report Capital Gains on Your Tax Return

Your broker or financial institution will send you a Form 1099-B by January 31st showing all sales you made during the year, including the purchase date, sale date, and proceeds. You use this form to fill out Schedule D (Capital Gains and Losses), which is part of your federal tax return. Schedule D separates short-term gains and losses from long-term ones and calculates your net gain or loss for the year.

If you have losses, you can use them to offset gains. If your losses exceed your gains, you can deduct up to $3,000 of the excess loss against ordinary income in that year, and carry forward any remaining loss to future years. This is why some people deliberately sell losing investments at year-end—to harvest the loss and reduce their tax bill.

When You Might Owe Estimated Tax Payments

If you expect a large capital gain in the current year—from selling a rental property, a business, or a significant investment—you may owe estimated tax payments to the IRS and your state. These are quarterly payments due on April 15, June 15, September 15, and January 15. If you don't pay enough through withholding or estimated payments, you may owe a penalty when you file your return, even if you ultimately don't owe any tax.

You can avoid the penalty if you pay at least 90% of your current year tax or 100% of your prior year tax (110% if your prior year income was over $150,000). If you expect a large gain, talk to a tax professional before the sale so you can plan the timing and make the right estimated payments.

Frequently Asked Questions

Do I owe capital gains tax if I sell at a loss?

No, you don't owe tax on a loss. Instead, you can use the loss to reduce any capital gains you have that year. If losses exceed gains, you can deduct up to $3,000 against other income, and carry forward the rest to future years.

How does the holding period work if I inherit stock?

Inherited stock is treated as long-term regardless of how long the deceased held it. You get a step-up in basis to the value on the date of death, so you owe no tax on any gain that occurred before you inherited it. Any gain after inheritance is taxed based on how long you hold it.

What if I sell a rental property I've owned for ten years?

You'll owe long-term capital gains tax on the difference between your sale price and your adjusted cost basis (the original purchase price plus improvements, minus depreciation deductions you claimed). You may also owe depreciation recapture tax at 25% on the depreciation you deducted. A tax professional can help you calculate the exact amount.

Can I avoid capital gains tax by donating the asset 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 donation. This is often more tax-efficient than selling and donating the proceeds, especially for highly appreciated assets.

Do I have to report the sale if the gain is small?

Yes, you must report all sales on Schedule D, even if the gain is small or zero. Your broker reports the sale to the IRS on Form 1099-B, so the IRS knows about it. Failing to report it can trigger an audit or penalty.