What are Capital Gains?
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If you’ve ever sold an investment at a profit—or even thought about selling—you’ve likely dealt with or anticipated capital gains. By learning the basics, you can make smarter choices, avoid unexpected tax bills, and keep more of your earnings.
How Capital Gains Work
Capital gains are the profits you make when selling something for more than you originally paid. This can apply to investments like stocks and bonds, or personal property like a second home or rare collectibles. The money you earn from these sales can impact your taxes, making it essential to understand how capital gains work.
Not all profits are taxed the same way. When and how you sell an asset plays a major role in what you owe the IRS.
Capital Assets and Realized Gains
A capital gain happens when you sell a capital asset, such as stocks, mutual funds, real estate, or art for more than what you paid. For example, if you bought a share of stock for $100 and sold it for $150, your gain is $50.
That gain only becomes taxable once the asset is sold. If your investment has increased in value but you haven’t sold it, that’s considered an “unrealized” gain and isn’t taxable yet. Tax liability kicks in when the gain is realized.
Short-Term vs. Long-Term
The length of time you hold an asset matters. If you own something for a year or less and sell it at a profit, the IRS considers it a short-term capital gain. These are taxed at your regular income tax rate.
Long-term capital gains apply when you’ve held the asset for more than one year. These gains are taxed at lower rates—either 0%, 15%, or 20%—depending on your income. For most investors, the 15% rate is typical.
How Capital Gains are Taxed
Capital gains taxes aren’t one-size-fits-all. The amount you pay depends on your income level, how long you held the asset, and where you live.
Federal Tax Rates
In 2025, the federal government applies the following long-term capital gains tax brackets:
- 0% for single filers with taxable income up to $47,025
- 15% for income between $47,026 and $518,900
- 20% for income above $518,900
Short-term gains are taxed at your ordinary income tax rate, which could be as high as 37% for high earners.
State and Local Taxes
Some states tax capital gains separately. Others, like California, treat them just like regular income. A few states—including Florida, Texas, and Washington—don’t have an income tax, which can make a big difference in what you owe.
If you live in a state with high income tax rates, your capital gains tax bill could be significantly higher than the federal rate alone.
Special Taxes for High Earners
If your income is above certain thresholds, you may owe an additional 3.8% Net Investment Income Tax (NIIT) on capital gains and other investment income. This applies to individuals with a modified adjusted gross income (MAGI) of over $200,000 and married couples with a MAGI of over $250,000.
Home Sales and Capital Gains
Selling your home may lead to a large gain, but there’s a tax break that helps many homeowners avoid paying capital gains tax on part—or all—of the profit.
The Primary Residence Exclusion
If you sell your primary residence, you may be able to exclude up to $250,000 in capital gains ($500,000 if you’re married filing jointly). To qualify, you must have both owned and lived in the home for at least two out of the past five years.
You can use this exclusion once every two years and only applies to your main home. If you meet the criteria, it’s possible to sell your house at a large profit without triggering a capital gains tax bill.
Rental and Investment Property
The rules are different for second homes and rental properties. These don’t qualify for the home sale exclusion. Instead, you may owe capital gains tax on the entire profit, and if you’ve claimed depreciation deductions in previous years, you could face additional tax through depreciation recapture.
This can catch people off guard, especially if the property has been held for many years and saw substantial value increases.
Offsetting Gains with Losses
Capital gains taxes can add up, but they can also be reduced—legally—if you have other investments that lost money.
Capital Losses and Tax Deductions
If you sell an asset for less than you paid, you’ve realized a capital loss. These losses can offset your capital gains. For example, if you gained $5,000 from one sale but lost $2,000 from another, you’ll only pay tax on the $3,000 net gain.
If your losses exceed your gains, you can deduct up to $3,000 from your regular income each year. Any amount over that can be carried forward to future years.
Watch Out for Wash Sales
Be careful when selling a stock at a loss. If you buy the same or a substantially identical stock within 30 days before or after the sale, the IRS may disallow the loss under the wash sale rule. That means you won’t be able to claim the deduction, and you’ll have to adjust your cost basis instead.
Reducing or Avoiding Capital Gains Tax
You may not be able to skip taxes entirely, but you can take steps to limit what you owe. With smart timing and use of tax rules, it’s possible to keep more of your investment gains.
Hold for the Long Term
The simplest way to lower your capital gains tax bill is to hold on to assets for more than one year before selling. This lets you benefit from the lower long-term capital gains rates. Even waiting just a few extra days or weeks could make a difference in how much tax you pay.
It’s especially important to keep track of your purchase and sale dates, so you know which bracket you fall into. Many investment platforms will label each sale as short- or long-term, but it’s still your responsibility to report them correctly.
Use Tax-Advantaged Accounts
Investing through retirement accounts like a Roth IRA, Traditional IRA, or 401(k) can help avoid capital gains taxes. In these accounts, you won’t pay tax on gains as your investments grow.
For Traditional IRAs and 401(k)s, taxes are deferred until you make withdrawals, which are then taxed as regular income. With a Roth IRA, qualified withdrawals are completely tax-free, meaning no capital gains tax at all. These accounts are beneficial for long-term planning and compounding gains over time.
Donate Appreciated Assets
Giving long-held investments to charity is another way to reduce your capital gains tax. When you donate appreciated assets instead of cash, you avoid paying tax on the gain and may also receive a charitable deduction for the full fair market value.
This strategy works best when donating stocks or mutual funds that have increased in value and that you’ve held for more than one year.
Filing Capital Gains on Your Taxes
When tax season arrives, accurate reporting of gains and losses is key. Mistakes can lead to audits or penalties, so it’s important to understand the process.
Forms You’ll Need
Capital gains and losses are reported on Form 8949 and Schedule D. Each sale, along with its purchase and sale dates, cost basis, and sale price, goes on Form 8949. These totals then carry over to Schedule D to calculate your overall tax owed.
If you use a broker or trading app, you’ll usually receive a 1099-B form that summarizes your sales and cost basis. However, the accuracy of this form depends on the data you and the broker provided. Always double-check for errors, especially on older assets or inherited property.
Crypto and Other Emerging Assets
Cryptocurrency gains are taxed the same way as traditional capital assets. Whether you sell, trade, or use crypto to make a purchase, any increase in value from the time you acquired it becomes taxable.
This applies even if you’re just exchanging one cryptocurrency for another. The IRS expects you to report each transaction with accurate records of your cost basis and holding period.
Exceptions and Special Circumstances
Some types of gains are treated differently under IRS rules. In certain situations, you may not owe any capital gains tax at all.
Income Thresholds
If your taxable income is below a certain level, you may qualify for a 0% tax rate on long-term capital gains. For single filers in 2025, that threshold is $47,025. For married couples filing jointly, it’s $94,050.
This can be especially helpful for retirees, students, or people with variable income. Planning the timing of your sales in a low-income year could help you pay no tax on some gains.
Inherited Property and Step-Up in Basis
When you inherit an asset, its cost basis is typically “stepped up” to its fair market value at the time of the original owner’s death. That means you may not owe capital gains tax if you sell the asset shortly after inheriting it, since there’s little or no gain between the step-up value and sale price.
This rule applies to most inherited property, including stocks, mutual funds, and real estate. It can make a big difference in estate planning and helps reduce tax burdens for heirs.
Divorce and Transfers
During a divorce, assets may be transferred from one spouse to another. These transfers typically don’t trigger capital gains taxes. However, if the receiving spouse later sells the asset, they take on the original cost basis and holding period, which may result in capital gains taxes down the line.
Understanding these rules can help both spouses plan for the future, especially when dividing property with significant potential gains.
Know the Rules, Save More
Capital gains are a fact of life for anyone who invests or owns valuable property. But they don’t have to catch you off guard. By understanding the difference between short- and long-term gains, using losses to your advantage, and making smart choices about when and how you sell, you can reduce your tax burden and improve your overall returns.
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