Understanding Long-Term vs. Short-Term Capital Gains Tax Rates

The difference between long-term and short-term capital gains lies in the length of time an investment is held or owned. Long-term capital gains are derived from investments held for more than one year, while a short-term capital gain results from an asset owned for one year or less.

The duration begins on the first day you own the asset and includes the day you sell or dispose of it. The distinction is important because short- and long-term capital gains are taxed very differently. The rate difference can be as much as 17% for long-term gains for some high-income individuals.

Short-term capital gains are taxed as ordinary income. Any income you receive from investments you held for less than a year must be included in your taxable income for that year and it's treated the same. If you have $60,000 in taxable income from salary and $5,000 from short-term investments, your total income is $65,000.

Based on the 2019 tax tables and assuming that you file using the single status, you would be in the 22% tax bracket at an income of $65,000, so you would pay 22% on your capital gain. The federal tax system is progressive, so the first $9,700 you earn is taxed at 10%, your income from $9,701 up to $39,475 is taxed at 12%, and your income from $39,475 to $65,000, including your gain, is taxed at 22%.

The IRS taxes long-term capital gains at a substantially reduced rate to encourage individuals and businesses to hold on to investments: 0%, 15%, or 20%.

The capital gains rates corresponded directly with income tax brackets before 2018, but that's changed. Long-term capital gains now have their own tax brackets, and they're more advantageous. For example, a single filer with taxable income between $9,700 and $39,475 per year would be in the 12% income tax bracket for short-term gains, but single taxpayers with total income up to $39,375 are in the 0% long-term capital gains bracket.

Those who earn just a bit more—$39,376 to $434,550—are in the 15% long-term capital gains bracket. The highest long-term capital gains rate of 20% applies only to those with taxable incomes of $434,551 or more.

You'd have a tax liability of $1,100 on your gain if you realize a $5,000 short-term gain and your taxable earned income is $40,000 for a total of $45,000. This puts you in the 22% ordinary income tax bracket (income from $39,475 to $84,200), and 22% of $5,000 is $1,100.

You'd have a tax liability on your gain of just $750 if you realize a $5,000 long-term gain and your overall income is $45,000. Your gain is no longer subject to ordinary income brackets but rather the special long-term gain rate of 15%, and 15% of $5,000 is $750.

The greater your overall income, the more important this distinction becomes.

Gains are calculated on your basis in an asset—what you paid to acquire it, less depreciation, plus costs of sale and costs of any improvements you made. You inherit the donor's basis when an asset is given to you as a gift. The original basis transfers to you unless the asset is inherited. In this case, the basis is stepped up to the date-of-death value.

Gains on collectibles and artwork are subject to their own rules. They're taxed at ordinary income rates regardless of how long you hold them, with a top rate of 28%.

The only way to qualify for the 0% capital gains rate is to earn less than $38,600 per year and hold your investments for 12 months or more, but you can employ other strategies to limit your tax burden.

If you own your home and are considering a sale, make sure you wait until you’ve lived in it for at least 24 of the last 60 months. If you own and occupy your primary residence for at least two years, you can exclude from taxation up to $250,000 of gain if you’re single, or $500,000 if you’re married filing jointly. Other qualifying rules apply as well.

If you own real estate as an investment and would like to sell, consider speaking with a tax professional about the 1031 exchange process. There are rules and regulations to keep in mind with this option as well, but a successful 1031 exchange allows you to sell property and reinvest the proceeds into new real estate without paying capital gains or depreciation recapture taxes.

If your net investment losses exceeded the maximum allowable deduction in the last tax year—$3,000 in 2019—you can carry over the excess to your current tax return to offset this year’s gains.

[Important: Investing within a qualified retirement account—like a 401(k) or an IRA—can allow you to reap the rewards of successful investing without paying capital gains when you sell appreciated assets.]

If you invest in a Roth account, you pay income taxes on your contributions in the year you earn them but will be able to withdraw your earnings tax-free after retirement, avoiding capital gains taxes completely. The 529 education savings plan offers similar tax advantages.

If you have underperforming investments you’d like to unload, consider selling them before the end of the tax year and using those losses to offset your gains. For those who need help, many managed investment services include tax strategy and loss harvesting guidance.

• Short-term gains are taxed as regular income according to tax brackets up to 37% as of 2019.
• Long-term gains are subject to special, more favorable tax rates of 0%, 15%, and 20% based on overall income.
• One year of ownership is the deciding factor. Short-term gains result from selling property owned for one year or less.