Capital gains taxes are a critical component of investment returns and overall financial planning. Understanding the difference between short-term and long-term capital gains — and how they are taxed — is essential for anyone who buys and sells assets like stocks, real estate, cryptocurrencies, or mutual funds. The IRS distinguishes these gains based on how long you held the asset before selling. This holding period directly impacts your tax rate, with potentially significant consequences for your refund or tax liability.
What Are Capital Gains?
A capital gain is the profit you realize when you sell a capital asset — such as stocks, bonds, real estate, or other investments — for more than its purchase price (your cost basis). The IRS requires you to report and pay taxes on these gains. Capital losses, conversely, occur when you sell an asset for less than what you paid for it, and they can be used to offset capital gains.
Short-Term Capital Gains Explained
Short-term capital gains arise when you sell an asset that you’ve held for one year or less. The IRS taxes these gains as ordinary income, meaning they are subject to the same tax rates as your wages or salary. These rates can range from 10% to 37% depending on your total taxable income and filing status.
Key Characteristics of Short-Term Gains
- Applies to assets held for one year or less
- Taxed at the taxpayer’s regular income tax rate
- Reported on Schedule D (Form 1040), Part I
- Less favorable treatment than long-term gains
Long-Term Capital Gains Explained
Long-term capital gains apply to assets held for more than one year. These gains receive preferential tax treatment compared to short-term gains. Depending on your income level, long-term capital gains are taxed at rates of 0%, 15%, or 20%.
Key Characteristics of Long-Term Gains
- Applies to assets held for more than one year
- Taxed at reduced capital gains tax rates
- Reported on Schedule D (Form 1040), Part II
- Can reduce your overall tax burden significantly
2025 Long-Term Capital Gains Tax Rates (By Filing Status)
| Rate | Single | Married Filing Jointly | Head of Household |
|---|---|---|---|
| 0% | Up to $44,625 | Up to $89,250 | Up to $59,750 |
| 15% | $44,626 to $492,300 | $89,251 to $553,850 | $59,751 to $523,050 |
| 20% | Over $492,300 | Over $553,850 | Over $523,050 |
Example Comparison
Let’s say you purchased 100 shares of a stock at $100 per share and sold them at $150 per share, generating a $5,000 gain.
- If sold within 12 months: The $5,000 is taxed as short-term gain at your ordinary income rate (e.g., 24% = $1,200 tax owed)
- If sold after 12 months: The $5,000 is taxed at the long-term capital gains rate (e.g., 15% = $750 tax owed)
The tax savings from holding the asset for more than a year is $450 in this example — a 37.5% reduction in tax liability on the gain.
Additional Surtaxes on Capital Gains
High-income earners may be subject to additional taxes on capital gains:
- Net Investment Income Tax (NIIT): 3.8% applies if your modified adjusted gross income (MAGI) exceeds $200,000 (single) or $250,000 (married filing jointly)
- State Capital Gains Taxes: Some states also tax capital gains, either at ordinary income rates or with special rates
Capital Losses: Offsetting Capital Gains
If you incur a capital loss, you can use it to offset your capital gains. If your losses exceed gains, you can deduct up to $3,000 ($1,500 if married filing separately) against ordinary income each year. Unused losses can be carried forward to future tax years.
Where to Report Capital Gains and Losses
- Schedule D (Form 1040): Summarizes all capital gains and losses
- Form 8949: Details individual transactions
- Form 1040, Line 7: Net capital gain or loss carried from Schedule D
Tax Planning Strategies
- Hold assets for more than one year to benefit from long-term rates
- Harvest losses to offset gains and reduce your tax liability
- Time sales around income changes — lower income may result in a 0% capital gains rate
- Use tax-advantaged accounts like IRAs or 401(k)s to defer or eliminate capital gains taxes
Conclusion
The distinction between short-term and long-term capital gains can significantly impact your tax liability. While short-term gains are taxed at higher ordinary income rates, long-term gains benefit from preferential tax treatment. Proper planning — including timing your sales, managing your income, and using losses strategically — can help you reduce your tax burden and retain more of your investment profits. Understanding these rules is essential for every investor, from first-timers to seasoned traders.
