Long-Term vs. Short-Term Capital Gains Tax
Many of us associate the new year with a clean slate and the opportunity for change and growth. While taxes may not be top of mind for all of us, there is truly no better time than the new year to start strategizing for next year's tax season.
Understanding capital gains tax is critical if you plan on profiting from your investments. Capital gains are profits from selling an asset. The IRS requires you to pay taxes on these gains. Only gains realized from the sale of an asset are subject to capital gains tax, while unrealized gains from appreciation are usually not taxed until you sell them.
Capital gains taxes are divided between long-term (over one year) and short-term (under one year) investments. Understanding the benefits and requirements for each can potentially save you a significant amount of money.
The Short Version
- Long-term capital gains are any profit you make on an asset that has been sold for over a year.
- A short-term capital gain is the profit made when you sell an asset held for less than a year.
- The tax rates for each are different. Long-term capital gains generally have a more favorable rate than short-term capital gains. Short-term capital gains are taxed as regular taxable income.
- How much you'll pay in taxes depends on a few factors, including your income level, and if you suffered any capital loss (i.e. if you lost money on any of your investments).
What Are Long-Term Capital Gains?
Long-term capital gains are profits made when you sell assets that have been held for over one year. The long-term capital gains tax rate depends on your income tax-bracket and your filing status.
Long-term capital gains are taxed at a more favorable rate than short-term capital gains, which are taxed as regular taxable income.
Long-Term Capital Gains Tax Rates
2022 Long-Term Capital Gains Tax Rates
| Tax filing status | 0% rate | 15% rate | 20% rate |
| Single | Up to $41,675 | $41,676 to $459,750 | Over $459,750 |
| Married filing jointly | Up to $83,350 | $83,351 to $517,200 | Over $517,200 |
| Married filing separately | Up to $41,675 | $41,676 to $258,600 | Over $258,600 |
| Head of household | Up to $55,800 | $55,801 to $488,500 | Over $488,500 |
Source: Internal Revenue Service
2023 Long-Term Capital Gains Tax Rates
| Tax filing status | 0% rate | 15% rate | 20% rate |
| Single | Up to $44,625 | $44,626 to $492,300 | Over $492,300 |
| Married filing jointly | Up to $89,250 | $89,251 to $553,850 | Over $553,850 |
| Married filing separately | Up to $44,625 | $44,626 to $276,900 | Over $276,900 |
| Head of household | Up to $59,750 | $59,751 to $523,050 | Over $523,050 |
Source: Internal Revenue Service
To use this chart, first determine your filing status. For example, let’s say you are the head of household and held a stock for over one year before selling it for $10,000 of profit in 2022. If your taxable income in 2022 was $40,000, and you had $10,000 of long-term capital gains from the stock sale, you would owe nothing on the $10,000 of long-term capital gains for taxes that year.
How Are Long-Term Capital Gains Calculated?
Long-term capital gains are taxed by subtracting your cost basis (what you paid) from the price at which you sell the asset after one year. If this number is positive, you have a capital gain. If it is negative, you have a capital loss.
For example, if you file as single for 2022 with a taxable income of $65,000 the chart above shows that you will pay 15% on long-term capital gains.
So if you bought 20 shares of XYZ stock at $5,000 in 2021 and sold them over a year later in 2022 for $6,000, you will be charged a federal tax rate of 15% on your long-term capital gain of $1,000, or $150. This leaves you with a profit of $850.
Keep in mind that your state may charge you an additional capital gains tax, further eating into your profits.
Note: Your cost basis should typically include any commissions or fees you paid upon purchase of the asset.
What Are Short-Term Capital Gains?
Short-term capital gains are profits made on the sale of assets that have been held for less than one year. Short-term capital gains are taxed as ordinary income and thus mirror the ordinary taxable income tax rates of 10%, 12%, 22%, 24%, 32%, and 37%.
Tax brackets for short-term capital gains and ordinary taxable income are also the same, while income from short-term investments usually adds to your total taxable income.
Short-Term Capital Gains Tax Rates
Tax Rates for Short-Term Capital Gains 2022
| Filing Status | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
| Single | Up to $10,275 | $10,276 to $41,775 | $41,776 to $89,075 | $89,076 to $170,050 | $170,051 to $215,950 | $215,951 to $539,900 | Over $539,900 |
| Married filing jointly | Up to $20,550 | $20,551 to $83,550 | $83,551 to $178,150 | $178,151 to $340,100 | $340,101 to $431,900 | $431,901 to $647,850 | Over
$647,850 |
| Married filing separately | Up to $10,275 | $10,275 to $41,775 | $41,776 to $89,075 | $89,076 to $170,050 | $170,051 to $215,950 | $215,951 to $323,925 | Over $323,925 |
| Head of household | Up to $14,650 | $14,651 to $55,900 | $55,901 to
$89,050 |
$89,051 to $170,050 | $170,051 to $215,950 | $215,951 to $539,900 | Over $539,900 |
Source: Internal Revenue Service
Tax Rates for Short-Term Capital Gains 2023
| Filing Status | 10% | 12% | 22% | 24% | 32% | 35% | 37% | |
| Single | Up to $11,000 | $11,001 to $44,725 | $44,726 to $95,375 | $95,376 to $182,100 | $182,101 to $231,250 | $231,251 to $578,125 | $578,126 or more | |
| Married filing jointly | Up to $22,000 | $22,001 to $89,450 | $89,451 to $190,750 | $190,751 to $364,200 | $364,201 to $462,500 | $462,501 to $693,750 | $693,751 or more | |
| Married filing separately | Up to $11,000 | $11,001 to $44,725 | $44,726 to $95,375 | $95,376 to $182,100 | $182,101 to $231,250 | $231,251 to $346,875 | $346,876 or more | |
| Head of household | Up to $15,700 | $15,701 to $59,850 | $59,851 to $95,350 | $95,351 to $182,100 | $182,101 to $231,250 | $231,251 to $578,100 |
|
Source: Internal Revenue Service
Federal income tax is a progressive system. If you filed as single and made $50,000 dollars in 2022, you are not taxed at 22% for the entire $50,000. Instead, you will be taxed at 10% for the first $9,950, 12% for income from $9,951 to $40,525, and 22% for the rest.
How Are Short-Term Capital Gains Calculated?
Short-term capital gains could push your taxable income into a higher tax bracket, meaning that those gains would be taxed at a higher rate.
For example, someone filing as head of household in 2022 with a personal income of $50,000 made short-term capital gains of $8,000. The threshold for their tax bracket in 2022 is $55,900. Therefore, $2,100 of their $8,000 gain would be taxed at 10% and the remaining $5,900 would be taxed at 22% (along with the rest of their income).
Differences Between Short-Term and Long-Term Capital Gains
The primary difference between short-term and long-term capital gains is that long-term capital gains are profits made on capital assets held for over one year, while short-term capital gains are profits made on capital assets held for less than one year.
Advantages and Disadvantages of Long-Term Capital Gains
Below are some advantages and disadvantages to consider when planning for long-term capital gains.
Advantages and Disadvantages of Short-Term Capital Gains
It’s not always possible to incur long-term capital gains. If incurring short-term capital gains, below are advantages and disadvantages to consider.
5 Ways to Minimize or Avoid Capital Gains Taxes
For those looking to plan their taxes most efficiently, here are five strategies to consider.
1. Hold the Stock for Over a Year
Holding a stock for more than a year typically qualifies it for the long-term capital gains tax rate and can save you significant sums of money.
For example, let’s say that someone filing as single with an annual income of $60,000 made an investment of $10,000 (bought in 2020) with a sale price of $13,000 (sold in 2021). If this person sold to collect their $3,000 capital gain before the one-year threshold, they would have paid 22% ($660) in taxes that year. However, if they held the investment for over a year, they would have paid 15% ($450), a savings of $210.
2. Claim the Home Sale Exclusion for Your Principal Residence
Your home is considered a capital asset and is subject to capital gains tax if the sale price is greater than the purchase price. However, there is an exclusion providing that you have lived in your primary residence for two out of five years prior to its sale date. If you file as single, there are no capital gains on the first $250,000 of profit; those filing as married will pay no capital gains tax on the first $500,000.
3. Use Tax-Advantaged Accounts
Tax-advantaged accounts incentivize saving long-term by reducing certain taxes you would have otherwise incurred as long as you follow the designated guidelines.
401(k): A 401(k) is a company-sponsored retirement account, potentially with company-matched contributions. Investment in a 401(k) is a tax advantage because it typically comes out of your paycheck prior to taxes (except for certain taxes such as Medicare and Social Security).
529 plan: Gains on investments put in a 529 plan for your children are usually not taxed when used for qualifying education expenses such as school tuition.
Traditional IRA / Roth IRA: IRAs are a great way to save on taxes, provided that you meet their restrictions. The primary difference between a traditional IRA and a Roth IRA is the timing of their respective tax advantages.
Find out more >>> How to Offset Your Taxes
4. Harvest Tax Losses to Offset Gains
You can offset taxes on capital gains with capital losses, a strategy known as tax loss harvesting. If you have no capital gains, you can usually realize capital losses of up to $3,000 to reduce your taxable income.
5. Donate to Charitable Causes
When you donate appreciated assets to charity, you typically will not have to pay capital gains taxes. You can usually still reduce your tax liability with an income tax deduction, of up to 60% of your adjusted gross income.
Things to Keep in Mind Before Selling Your Investments
When planning your exit strategy, it’s important to make sure you’ve carefully considered the tax consequences in addition to your financial situation.
If you sell stocks, be aware of wash sale rules. You have to wait at least 30 days after you sell investments before purchasing substantially similar assets. If you don't, you will lose the tax incentive. For example, if you sell XYZ stock at a loss and then buy the same XYZ stock back within 30 days, you may not be able to harvest the loss. Find out more in our wash sale rules guide.
Before selling an asset, you should consider whether the one-year threshold is approaching as it could become long-term capital gains.
If you are selling a property, keep in mind that you are eligible for a capital gains tax exemption on your primary residence if you have used the property as your main residence for a total period of two out of five years from its sale date. Additionally, the cost of improvements on a property may add to your cost basis, thus reducing taxable gains.
Keep Reading >>> How to Avoid Capital Gains Tax on Your Investments
Final Thoughts
It’s important to understand the differences between long-term and short-term capital gains, as it could save you a lot of tax expenses down the line. Capital gains tax policies typically provide incentives for long-term investors. If you'd like help with efficiently planning your exits, consulting with a tax professional could be a good first move.
Disclaimer: The content presented is for informational purposes only and does not constitute financial, investment, tax, legal, or professional advice. If any securities were mentioned in the content, the author may hold positions in the mentioned securities. The content is provided ‘as is’ without any representations or warranties, express or implied.
