Short-Term vs Long-Term Capital Gains: What’s the Difference?

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If you own a home, car, cryptocurrency, or shares of a company’s stock, you have capital assets. Selling these items for a profit could trigger a capital gains tax. As is standard with the U.S. tax system, the capital gains tax isn’t easily understood.

What are Short-Term vs Long-Term Capital Gains?

Short-term capital gains and long-term capital gains refer to how long you owned an asset, and further, how much you’ll be taxed.

Also known as the holding period, the clock starts ticking the day after you buy the asset and lasts up to, and including, the day you sell the asset. In the context of capital gains, short-term means 12 months or less and long-term means more than 12 months.

What is a Capital Gains Tax?

A capital gains tax applies to the net gain you receive from selling a capital asset. How much you pay depends mostly on these factors:

  • Your holding period
  • Your net gain (the sale price less your adjusted basis)
  • Your income
  • Your tax filing status

The Difference Between Long-Term and Short-Term Capital Gains

The big difference between long-term vs short-term capital gains is how they’re taxed.

Short-term capital gains are taxed like other ordinary income, such as wages from a job. Your gains are simply added to your gross income and taxed according to your federal tax rate. Long-term capital gains are taxed separately at rates between 0% and 20%, though in a few instances they may be taxed at a higher rate.

Any type of capital asset can result in a short- or long-term capital gain.

Read More: Guide to Filing Your Taxes in 2022

Long-Term Capital Gains Tax Rates

Following are the tax rates and income thresholds for long-term capital gains in the 2022 tax year.

Long-term capital gains rates for 2022

Tax Rate Single Married Filing Jointly Head of Household Married Filing Separately
0% $0 to $41,675 $0 to $83,350 $0 to $55,800 $0 to $41,675
15% $41,676 to $459,750 $83,351 to $517,200 $55,801 to $488,500 $41,676 to $258,600
20% $459,751 or more $517,201 or more $488,501 or more $258,601 or more

Short-Term Capital Gains Tax Rates

The tax rates for short-term capital gains are the same rates that apply to ordinary income. Like long-term capital gains taxes, the income thresholds are also adjusted each year for inflation.

Short-term capital gains rates for 2022

Tax Rate Single Married Filing Jointly Head of Household Married Filing Separately
10% $0 to $10,275 $0 to $20,550 $0 to $14,650 $0 to $10,275
12% $10,276 to $41,775 $20,551 to $83,550 $14,651 to $55,900 $10,276 to 41,775
22% $41,776 to $89,075 $83,551 to $178,150 $55,901 to $89,050 $41,776 to $89,075
24% $89,076 to $170,050 $178,151 to $340,100 $89,051 to $170,050 $89,076 to $170,050
32% $170,051 to $215,950 $340,101 to $431,900 $170,051 to $215,950 $170,051 to $215,950
35% $215,951 to $539,900 $431,901 to $647,850 $215,951 to $539,900 $215,951 to $323,925
37% $539,901 or more $647,851 or more $539,901 or more $323,926 or more

How to Calculate Capital Gains Tax

Follow these steps to determine long-term capital gains tax.

  1. Determine your adjusted basis. If you bought the asset, this is the purchase price plus any commissions, fees, or improvements (this is common for real estate) that you paid for. If you inherited the asset, this is either the fair market value on the day of the original owner’s death or the fair market value on the day the asset was transferred to you, plus commissions, fees, or improvements. If the asset was a gift, this is the original owner’s adjusted basis, plus commissions, fees, or improvements.
  2. Subtract your adjusted basis from the amount you sold the asset for. If the number is positive, you have a capital gain. If it’s negative, you have a capital loss.
  3. Reduce your long-term gains by the amount of long-term losses you incurred in the same year or carried over from previous years. 
  4. Revisit the long-term capital gains tax table. Find the bracket that represents your taxable income, which is your gross income minus all deductions.
  5. The corresponding tax rate — either 0%, 15%, or 20% — applies to your net capital gain. (Note that you may be responsible for an additional investment income tax if your income is in the six figures).

Follow these steps to find short-term capital gains tax:

  1. Repeat steps 1 through 3, above.
  2. Reduce your short-term gains by the amount of short-term losses you incurred in the same year or carried over from previous years.
  3. Revisit the ordinary income tax table. Find the bracket that represents your taxable income (this amount includes your net short-term capital gain).
  4. The corresponding tax rate is your marginal tax rate, or the rate at which your last dollar of income will be taxed.

Example of Calculating Capital Gains Tax

Let’s look at a real-world example of long-term capital gains tax for Jane, whose taxable income for 2022 is $50,000.

  1. Two years ago, Jane bought a stock fund for $1,000 and paid a $50 commission. Her basis in the asset is $1,050.
  2. She recently sold the stock fund for $1,500. So, her capital gain is $450.
  3. She sold another investment at a loss this year and has $100 in long-term capital losses. So, her net capital gain is $350.
  4. A 15% tax rate will apply to her $350 gain. The resulting tax is $52.50.

Read More: Guide to Tax-Loss Harvesting

States That Don’t Tax Capital Gains

We’ve been discussing how capital gains are taxed at the federal level. While many states also tax capital gains according to a unique system, these nine states don’t tax income (including capital gains) at all:

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

How to Avoid Capital Gains Tax

Avoiding or minimizing capital gains tax comes down to being proactive. The easiest way to lock to reduce your tax bill is to hold on to an asset for longer than a year.

You can also reduce or eliminate capital gains tax through tax-loss harvesting, which is the process of selling underperforming investments and using the loss to offset gains. The remaining gain, if any, is the only amount subject to taxation.

You can also avoid capital gains tax by investing in tax-advantaged retirement accounts and donating appreciated assets to charity.

Read More: How to Avoid Capital Gains Tax

Capital Gains Exceptions

Not all capital gains are taxed at the standard rates outlined in the tables above. Here are the exceptions:

  • Gains from the sale of section 1202 qualified small business stock are taxed at 28%.
  • Gains from the sale of collectibles (e.g. stamps, coins, art, antiques) are taxed at 28%.
  • Gains from section 1250 depreciable real estate is taxed up to 25%.
  • Gains from the sale of owner-occupied real estate (i.e. a primary residence) are exempt from taxation up to $250,000 per individual and $500,000 per married couple filing a joint tax return.

Advantages of Long-Term Capital Gains

Most people will enjoy a nice tax break if they can hold on to an asset for longer than a year.

This doesn’t mean there isn’t a benefit to holding an investment short term. Of course, prices aren’t fixed. Our scenario is hypothetical, and it’s unlikely someone would be able to net the exact same gain (before taxes) on an asset at different points in time. The value of assets such as stocks or cryptocurrency can swing wildly. Some investors earn their keep by making calculated moves that require buying and selling frequently.

Note that there’s also the issue of the net investment income tax (NIIT), which applies  to short- and long-term capital gains. If your adjusted gross income exceeds $200,000 as a single filer or $250,000 as a joint filer, you could owe an additional 3.8% net investment income tax regardless of whether your gain is short or long term.

The Bottom Line

Differentiating between short- and long-term investments is the first step to figuring your tax on capital gains. Remember that the tax applies to your net gain, so don’t forget to apply your capital losses.

A tax professional or financial advisor can help you calculate your capital gains tax and implement strategies for minimizing or avoiding it in the future.

Learn More About Personal Capital’s Financial Advisors

 

Author is not a client of Personal Capital Advisors Corporation and is compensated as a freelance writer.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. Compensation not to exceed $500. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money. Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

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