What Is a Capital Gain?
A capital gain refers to the increase in the value of a capital asset that is realized when it is sold. In other words, a capital gain occurs when you sell an asset for more than what you paid to purchase it.
The Internal Revenue Service (IRS) taxes individuals on capital gains under certain circumstances.
Almost any type of asset you own is a capital asset. They can include investments such as stock, bonds, or real estate, and items purchased for personal use, such as furniture or a boat.
Key Takeaways
- A capital gain is the increase in a capital asset's value that is realized when the asset is sold.
- Capital gains apply to any type of asset, including investments and items purchased for personal use.
- The gain may be short-term (one year or less) or long-term (more than one year) and must be reported on income tax returns.
- Unrealized gains and losses reflect an increase or decrease in an investment's value but are not considered taxable.
- A capital loss is incurred when a capital asset is sold for less than its purchase price.
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Understanding Capital Gains
As noted above, capital gains represent the increase in the value of an asset. These gains are typically realized at the time that the asset is sold, and are often associated with investments, such as stocks and funds, due to their inherent price volatility.
But they can also be realized on any security or possession that is sold for a price higher than the original purchase price, such as a home, furniture, or vehicle.
Short- and Long-Term Capital Gains
Capital gains fall into two categories:
- Short-term: Gains realized on assets that you've sold after holding them for one year or less
- Long-term: Gains realized on assets that you've sold after holding them for more than one year
Both short- and long-term gains must be reported on your annual tax return. Understanding the distinction between them and factoring it into an investment strategy is particularly important for day traders and others who trade securities online.
Realized gains trigger a taxable event. Unrealized gains, sometimes referred to as paper gains, reflect an increase in the value of an investment that hasn't been sold. For example, if you own stock that goes up in price, but you haven't yet sold it, you have an unrealized gain. It is not a taxable event.
A capital loss is the opposite of a capital gain. It is incurred when a capital asset is sold for less than its purchase price.
Capital Gains Tax
Short- and long-term capital gains are taxed differently. Tax-efficient investing can lessen the impact of these taxes.
As mentioned, short-term gains occur for assets held for one year or less. These gains are taxed as ordinary income at a rate based on an individual's tax filing status and adjusted gross income (AGI).
Long-Term Capital Gains Tax Rates: 0%, 15%, 20%
On the other hand, long-term capital gains are taxed at lower rates than ordinary income tax rates. These rates are 0%, 15%, and 20%.
The exact rate that will be applied to your long-term capital gain depends on your taxable income and filing status. The 0% and 15% rates apply as long as income stays at or under a certain maximum amount. If you have more income than the maximum amount allowed for the 0% rate, then the gain is taxed at the 15% rate.
When the 20% Rate Applies
If you have more income than the maximum amount allowed for the 15% rate, then the gain is taxed at 20%.
The rates for tax years 2024 and 2025 and their corresponding maximum taxable incomes are shown below:
| Maximum Amounts for Capital Gains Rates for 2024 and 2025 | ||||
|---|---|---|---|---|
| Filing Status | 2024 Maximum Amount for 0% Rate | 2024 Maximum Amount for 15% Rate | 2025 Maximum Amount for 0% Rate | 2025 Maximum Amount for 15% Rate |
| Single | $47,025 | $518,900 | $48,350 | $533,400 |
| Married Filing Separately | $47,025 | $291,850 | $48,350 | $300,000 |
| Head of Household | $63,000 | $551,350 | $64,750 | $566,700 |
| Married Filing Jointly | $94,050 | $583,750 | $96,700 | $600,050 |
| Surviving Spouse | $94,050 | $583,750 | $96,700 | $600,050 |
| Estates & Trusts | $3,150 | $15,450 | $3,250 | $15,900 |
Special Capital Gains Tax Rules
Note that there are some caveats. Certain types of stock or collectibles may be taxed at a higher 28% rate, and real estate gains can go as high as 25%.
In addition, certain types of capital losses are not deductible. If you sell your house or car at a loss, you will be unable to treat it as a tax deduction. However, when you sell your primary home, the first $250,000 is exempt from the capital gains tax. That figure doubles to $500,000 for married couples.
High-net-worth investors may have to pay an additional net investment income tax on top of the 20% they will most likely owe.
Assets Eligible and Ineligible for Lower Tax Rates
Not all investments are eligible for the lower long-term capital gains tax rates.
| Eligibility of Certain Assets for Capital Gains Tax Treatment | |
|---|---|
| Eligible | Not Eligible |
| Stocks | Business inventory |
| Bonds | Depreciable business property |
| Jewelry | Real estate used by your business or as a rental property |
| Cryptocurrency (including NFTs) | Copyrights, Patents, and Inventions |
| Homes and Household furnishings | Literary or Artistic Compositions |
| Vehicles | |
| Collectibles | |
| Timber | |
| Fine artworks | |
Capital Gains and Mutual Funds
Mutual funds that accumulate realized capital gains throughout the tax year must distribute these gains to shareholders. Many mutual funds distribute them right before the end of the calendar year.
Shareholders who receive a distribution will get a 1099-DIV form detailing the amount of the capital gain and the type: short- or long-term.
Undistributed long-term capital gains are reported to shareholders on Form 2439. When a mutual fund makes a capital gain or dividend distribution, the net asset value (NAV) drops by the amount of the distribution. This distribution does not impact the fund's total return.
Taxes
Tax-conscious mutual fund investors should determine a mutual fund's unrealized accumulated capital gains, which are expressed as a percentage of its net assets, before investing in a fund with a significant unrealized capital gain component.
This circumstance is referred to as a fund's capital gains exposure. When distributed by a fund, such gains are a taxable obligation for the fund's investors.
Example of Capital Gains
Here's a hypothetical example to show how capital gains work and how they're taxed. Let's say Max purchased 100 shares of Amazon (AMZN) stock on Jan. 30, 2020, at $350 per share. He then decided to sell all the shares on Jan. 30, 2024, at $833 each.
Assuming there were no fees associated with the sale, Max realized a capital gain of $48,300: ($833 x 100) - ($350 x 100).
Max is single and has taxable income of $80,000 per year, which puts him in the income group ($47,025+ to $518,900) that qualifies for a long-term capital gains tax rate of 15%.
Therefore, Max should owe $7,245 in tax ($48,300 x 0.15) for this long-term capital gain.
What Qualifies As a Capital Gain?
Broadly speaking, whenever you sell a capital asset for more than the price at which you originally bought it, you have a capital gain.
At What Income and Age Do You Not Pay Capital Gains Tax?
For the tax year 2024, those whose income is $47,025 or less pay a 0% capital gains tax. There are no age-based criteria that exempt one from paying a capital gains tax.
How Are Capital Gains Taxed?
Short-term capital gains (assets held for one year or less) are taxed as ordinary income at a rate based on the individual's tax filing status and adjusted gross income. Long-term gains (assets held for more than one year) are usually taxed at a lower rate than ordinary income tax rates.
What Is a Net Capital Gain?
The IRS defines a net capital gain as the amount by which a net long-term capital gain (long-term capital gains minus long-term capital losses and any unused capital losses carried over from prior years) exceeds a net short-term capital loss (short-term capital gain minus short-term capital loss). A net capital gain may be subject to a lower tax rate than the ordinary income tax rate.
How Do I Lower Capital Gains Tax on My House?
You can reduce the capital gains tax on your home by living in it for more than two years and keeping the receipts for any home improvements that you make. The cost of these improvements can be added to the cost basis of your house and reduce the overall gain that will be taxed.
The Bottom Line
Capital gains are the profits that are realized by selling an asset, such as stocks, bonds, or real estate, for a profit. Long-term capital gains taxes are lower than ordinary income taxes, providing a tax advantage to many taxpayers, including homeowners and investors. Moreover, capital losses can sometimes be deducted from one's total tax bill.
For these reasons, all those holding assets that they may sell should understand when and how capital gains taxes apply.
