Capital gains and losses are divided between short-term and long-term, and there are other special categories.
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The tax law requires you to sort your capital gains and losses into categories. The theory behind these rules is that you gather all the gains and losses within a single category to figure out the overall result for that category before combining the results with another category. For example, if you have both gains and losses in the short-term category, you’ll combine them to find the net amount of short-term gain or loss. You can’t mix categories until after you’ve worked out the net amount within each category. After that, if you have gain in one category and loss in another, you combine the two.
The most important categories of gain or loss are determined by your holding period for the asset you sold. (There are also some special categories for certain types of assets.) For stocks, your holding period is generally determined by the amount of time that elapses between the trade date of your purchase and the trade date of your sale. But if you acquired your stock other than by purchase your holding period may relate to some earlier date. For example, if you receive additional stock as a result of a stock split, the new stock has the same holding period as the stock you already held. Your holding period may also be affected by a wash sale.
If the trade date of the sale is one year or less after the trade date of the purchase, you have a short-term capital gain. For example, if you bought on May 12, 2023 and sold on May 12, 2024 you have a short-term gain, because you must hold for more than one year to have a long-term gain. Short-term capital gain is taxed at the same rate as ordinary income (like wages and interest income), unless you have a capital loss that eliminates it.
If your gain isn’t short-term, then it’s long-term.
If the trade date of the sale is more than one year after the trade date of the purchase you have a long-term capital gain. As of 2018 you pay 0% tax on this category of gain if your overall income (including this gain) is low enough, 15% in a middle range of income, and 20% if income exceeds that range.
Example: Before counting any capital gain, your taxable income is $4,000 below the level where capital gain becomes taxable. You have a $10,000 long-term capital gain. The first $4,000 of this capital gain is taxed at 0% (in other words, it is tax-free). The rest is taxed at 15%.
Investment and other?
Some people are concerned that they may not be allowed to use capital losses from one source to offset capital gain from another source. Generally this is not a problem. For example, if you have a capital gain from selling your home (beyond the amount you can exclude), you can use a capital loss from a stock investment to reduce or eliminate that gain.
There are additional categories of long-term gain or loss, summarized below. Each of the rates mentioned below is a maximum rate. That means the rate will reduce your taxes if you would otherwise pay a higher rate — but it won’t increase your taxes if your regular tax rate is lower. For example, if you receive 28% gain when your regular rate is 15%, your tax on that gain will be 15% unless the gain is large enough to push you up into the next tax bracket.
- Certain gains from collectibles are treated as 28% gain even if it would otherwise qualify for the lower rates that normally apply to long-term capital gain.
- Certain gains from sales of real property are taxed at a special 25% rate.
This may seem a little complicated — and it is. Perhaps Congress will simplify capital gains at some point. Meanwhile these are the capital gain categories we have to deal with.