What are Capital Gains

By Thomas May AWMA, CRPC, CLTC

When it comes to investing, understanding capital gains is essential. Capital gains represent the profit earned from the sale of investments such as stocks, real estate, or other assets. This blog post will explain what capital gains are, how they are taxed, and what you can do to manage your tax liability. 

Understanding Capital Gains 
Capital gains occur when you sell an asset for more than you paid for it. These gains are categorized into two types: 

• Short-Term Capital Gains: Profits from assets held for one year or less. These are taxed at your ordinary income tax rate, which can be as high as 37%.
• Long-Term Capital Gains: Profits from assets held for more than one year. These benefit from lower tax rates — 0%, 15%, or 20% — depending on your income level.

You only pay taxes on capital gains once you sell the asset and realize the gain. Simply holding an investment that has increased in value does not trigger a tax event.

Capital Gains Tax Rates 
Long-Term Capital Gains 
For tax year 2024:

• 0% if your income is up to $47,025 (single filers). 
• 15% for incomes between $47,025 and $518,900. 
• 20% for incomes above $518,900. 

For tax year 2025:

• 0% if your income is up to $48,350. 
• 15% for incomes between $48,350 and $533,400. 
• 20% for incomes above $533,400. 

Short-Term Capital Gains 
Short-term capital gains are taxed like ordinary income. In 2024, single filers can face tax rates from 10% to 37% depending on their income bracket. 

Calculating Capital Gains 
To calculate your capital gain:

• Basis: This is the original purchase price plus additional costs such as fees or home improvements.
• Capital Gain: Subtract the basis from the sale price of the asset.

For example, if you bought a stock for $1,000 and sold it for $1,500, your capital gain is $500.

Earned vs. Unearned Income 
The IRS differentiates between:

• Earned Income: Wages and salaries.
• Unearned Income: Profits from investments like interest, dividends, and capital gains. 
  Unearned income, including long-term capital gains, usually receives more favorable tax treatment than earned income. 

Reducing Capital Gains Taxes 
One effective method to lower capital gains taxes is tax-loss harvesting. This strategy involves selling underperforming investments to offset gains from successful ones, reducing your overall taxable income while staying fully invested in the market. 

State Taxes on Capital Gains 
In addition to federal taxes, many states tax capital gains as regular income. However, states like Florida and Texas, which have no state income tax, do not levy a state capital gains tax. High-tax states like California and New York apply significant state taxes to capital gains.

Capital Gains and Real Estate 
When selling a primary residence, you may exclude:

• Up to $250,000 of capital gains if single.
• Up to $500,000 if married filing jointly. 

You must have lived in the home for at least two of the five years before the sale to qualify. For inherited property, a stepped-up basis allows the heir to use the property’s market value at the time of inheritance as the basis, reducing potential capital gains taxes. 
For investment properties it is important to understand the potential for taxation of a depreciable asset. Check out this article for more information. 

Net Investment Income Tax (NIIT) 
High earners may also owe the Net Investment Income Tax (NIIT) of 3.8%. This tax applies if your income exceeds:

• $200,000 for single filers.
• $250,000 for married filing jointly. 
  It covers income from capital gains, dividends, interest, and rental income. 
  

FAQ About Capital Gains 
What triggers a capital gains tax? 
A capital gains tax is triggered when you sell an asset for more than its basis (purchase price plus adjustments).

How can I minimize my capital gains taxes? 
Holding investments for over a year qualifies for lower tax rates. You can also use tax-loss harvesting to offset gains.

Are capital gains taxed at the state level? 
Yes, in most states. However, some states with no income tax do not tax capital gains.

What is a stepped-up basis in real estate? 
When you inherit property, the basis is "stepped up" to its market value at the time of inheritance, potentially reducing capital gains taxes when sold.

Do I have to pay capital gains taxes if I don’t sell my investments? 
No. Taxes are only due when the asset is sold and the gain is realized.