Understanding Capital Gains Taxes on Investments
Capital gains taxes apply to profits from selling investments like stocks, bonds, real estate, or other assets. The IRS taxes capital gains differently based on holding period: short-term gains (assets held one year or less) are taxed as ordinary income, while long-term gains (over one year) receive preferential lower rates. This tax treatment significantly impacts investment returns and after-tax wealth accumulation.
Long-term capital gains rates are 0%, 15%, or 20% depending on taxable income. For 2024, single filers pay 0% up to $44,625, 15% from $44,626 to $492,300, and 20% above $492,300. These thresholds are roughly double for married filing jointly. Additionally, high earners pay a 3.8% Net Investment Income Tax (NIIT) on investment income when modified adjusted gross income exceeds $200,000 (single) or $250,000 (married).
Short-term capital gains receive no preferential treatment—they're taxed at ordinary income rates from 10% to 37%. A $10,000 short-term gain for a taxpayer in the 24% bracket costs $2,400 in federal taxes, while the same long-term gain costs only $1,500 (15% rate). This 9-percentage-point difference makes holding investments over one year highly valuable for tax efficiency.
Cost basis calculation determines your taxable gain. Basis equals purchase price plus acquisition costs (commissions, fees) minus depreciation (for real estate). When selling stocks, you can choose specific shares to minimize taxes. Selling shares with the highest cost basis reduces gains and taxes owed. Without specific identification, the IRS assumes first-in-first-out (FIFO) accounting.
Tax-loss harvesting allows offsetting capital gains with capital losses. Losses first offset gains of the same type (short-term losses offset short-term gains), then offset gains of the opposite type. Excess losses up to $3,000 annually can offset ordinary income, with remaining losses carrying forward indefinitely. Strategic loss harvesting in down markets creates tax benefits that increase after-tax investment returns.