Capital Gains

Background

When you buy a stock, bond, or a longer-term asset, like a house or fine jewelry, its value can grow over time. If one of those “capital assets” grows in value and you decide to sell it, your “capital gains” would be roughly the difference between your original purchase price and the amount of money you sell the asset for.

Capital gains are also considered a form of income. But there’s one major difference between capital gains and the income you earn from your job: Capital gains can be taxed at a different rate, depending on a multitude of factors.

Capital Gains Explained

Let’s say an investor bought a share of stock for $5. If that investor then sold it for $140, their capital gains would be roughly $135. To figure out the exact amount, they would need to calculate the cost basis—the purchase price of that share adjusted for things like reinvested dividends and broker commissions.

At tax time, the IRS levies taxes not just on income from an investor’s job but also on what they’ve earned from asset sales that year. In the above example, the $135 capital gain is the taxable amount. How much tax the investor owes would be based on whether it was a short- or long-term capital gain, their taxable income, and their filing status.

Short-term capital gains occur when an investor sells for a profit in one year or less—for most investors, these gains are taxed at ordinary income tax rates. Long-term capital gains are profits earned after holding an asset for more than a year. These gains are typically taxed at a lower rate than an investor’s ordinary income tax rate.

Tax Considerations

People often try to reduce how much they owe in capital gains taxes by holding on to their assets for longer before they sell them.

For example, in 2024, a single filer making anywhere between $200,001 and $243,725 per year would pay a 15% tax on long-term capital gains. But when it comes to short-term capital gains, they’d be taxed at the same rate as their normal income, which, in their case, is 32%—see the full schedule here.

In other words, high earners have an incentive to hold on to their capital assets longer to avoid steeper tax bills.

Investing via tax-advantaged accounts, including 401(k) plans, 529 college savings plans, and IRAs is another method some people use to reduce their capital gains tax bills. Investors can buy and sell assets within these accounts without paying taxes on any capital gains until retirement, and in some cases, they won’t pay capital gains taxes at all.

Some people sell certain assets at a loss to offset gains on other assets and reduce the amount they pay in taxes. This process is called “tax-loss harvesting.” To put it another way, if someone earned $5K in capital gains, they might want to sell another asset at a $5K loss to cancel out their liability.

Political Controversy

The controversy over how capital gains are taxed is at least as old as the 16th Amendment, which was passed in 1913 and paved the way for federal capital gains taxes (learn more about historical capital gains tax rates here).

Some policymakers take issue with long-term capital gains being taxed at a preferential rate compared to income from paid work. Separately, the concept of taxing unrealized capital gains—when an asset’s value increases, but has yet to be sold—has been increasingly debated.

Other policymakers in recent years have supported lowering the highest long-term capital gains tax rate and are generally opposed to levying taxes on unrealized capital gains. They believe doing so could spur economic growth and job creation.