Taxation in the US: Capital Gains (Part 2 of 2)

In the United States of America, individuals and corporations pay U.S. federal income tax on the net total of all their capital gains. The tax rate depends on both the investor's tax bracket and the amount of time the investment was held. Short-term capital gains are taxed at the investor's ordinary income tax rate and are defined as investments held for a year or less before being sold. Long-term capital gains, on dispositions of assets held for more than one year, are taxed at a lower rate.

Current law.

The United States taxes short-term capital gains at the same rate as it taxes ordinary income.

Long-term capital gains are taxed at lower rates shown in the table below. (Qualified dividends receive the same preference.)

 unrecaptured Section 1250 gain — the portion of gains on depreciable real estate (structures used for business purposes) that has been or could have been claimed as depreciation — is capped at 25%.

The income amounts ("tax brackets") were reset by the Tax Cuts and Jobs Act of 2017 for the 2018 tax year to equal the amount that would have been due under prior law. They will be adjusted each year based on the Chained CPI measure of inflation. These income amounts are after deductions: There is another bracket of income below that shown as $0 in the table, on which no tax is due. For 2018, this amount is at least the standard deduction, $12,000 for an individual return and $24,000 for a joint return, or more if the taxpayer has over that amount in itemized deductions.

Additional taxes.

There may be taxes in addition to the tax rates shown in the above table.

Taxpayers earning income above certain thresholds ($200,000 for singles and heads of household, $250,000 for married couples filing jointly and qualifying widowers with dependent children, and $125,000 for married couples filing separately) pay an additional 3.8% tax on all investment income. This tax is known as the net investment income tax. Therefore, the top federal tax rate on long-term capital gains is 23.8%.

State and local taxes often apply to capital gains. In a state whose tax is stated as a percentage of the federal tax liability, the percentage is easy to calculate. Some states structure their taxes differently. In this case, the treatment of long-term and short-term gains does not necessarily correspond to the federal treatment.

Capital gains do not push ordinary income into a higher income bracket. The Capital Gains and Qualified Dividends Worksheet in the Form 1040 instructions specifies a calculation that treats both long-term capital gains and qualified dividends as though they were the last income received, then applies the preferential tax rate as shown in the above table. Conversely, however, this means an increase in ordinary income will withdraw the 0% and 15% brackets for capital gains taxes.