Capital Gains Tax: Definition, Rates & Calculation

If you make money from just about any source, you’re likely to find Uncle Sam nearby. It’s true of money you earn from a job, and it’s true of money you earn from investments, whether that’s stocks, real estate or collectibles. Any profit you earn from selling an investment is known as a capital gain, and the tax on this form of income is called the capital gains tax. 

Depending on how long you’ve held the asset before selling it, you’ll be taxed at either the short-term or long-term capital gains rate. In this article we’ll explain how the capital gains tax works, the difference between long- and short-term capital gains and the rates you’ll pay on the federal and state levels. We’ll also discuss how to minimize the tax impact on your investments.

A financial advisor can help you tax-optimize your investment portfolio. Find a financial advisor today.

What Are Capital Gains, and How Are They Taxed?

When you buy an investment asset, you’re hoping that it will appreciate in value, thereby giving you the option to sell it for more than you initially paid for it. If you do, these profits are referred to as “capital gains” by the government.

For example, let’s say you buy 10 shares of a company at $12 each, then later sell them at $15 a share. In this case, you have capital gains of $30.

Of course, you won’t always be so lucky. Let’s say another investment doesn’t do as well, and you sell it for less than what you originally paid for it. This is referred to as a capital loss.

At the end of the year, you tally up your capital gains and losses. If you’ve had a good year and your gains exceed your losses, then you’ll deduct your losses from your gains to find your net capital gains.

These gains constitute income, so the federal government (as well as some state governments) will tax them. This is known as the capital gains tax.

Capital Gains Tax Rates: Short-Term vs. Long-Term

The timeline on which you purchase and sell your assets comes into play for capital gains taxes. The government splits capital gains into two categories: short-term and long-term. For investment profits to be considered “long-term,” the asset must be held by the owner for at least one year before sale. Any profits from the sale of assets held for less time than that are considered “short-term” capital gains.

Short-term capital gains are taxed at ordinary income tax rates. This can become problematic for those with a high income, as federal income tax rates can reach as high as 37%. And that doesn’t even account for state taxes.

Long-term capital gains, on the other hand, receive special tax treatment. The top federal long-term capital gains rate is 20%, which is lower than all but two of the seven ordinary income tax rates. The other long-term capital gains tax rates are 0% and 15%.

Here is a breakdown of what rates your long-term capital gains will be taxed at for the 2026 tax year.

Federal Tax Rates for Long-Term Capital Gains

Again, short-term capital gains are taxed using the same rates as ordinary income taxes, which are much higher than the rates above. So, short-term capital gains are added to your taxable income for the year, and you are charged marginal rates based on which brackets your income falls within. 

Here’s an overview of the short-term capital gains rates for the 2026 tax year.

Federal Ordinary Income Tax Rates for Short-Term Capital Gains

How to Calculate Capital Gains Taxes

The first thing you need to determine when calculating capital gains taxes is how much you earned and lost from investments during the tax year. Once you know this, you can subtract your capital losses from your capital gains to get your net capital gains. This is what will be subject to taxes.

Next, you need to figure out which of those capital gains are short-term and long-term. Again, long-term capital gains means at least one year elapsed between the purchase and sale of the asset. Short-term capital gains means less than one year passed between the purchase and sale of the asset.

Long-term capital gains are taxed using a 0% to 20% tax schedule, whereas short-term capital gains are taxed like ordinary income. Long-term taxes work similarly to income taxes, as their brackets are marginal. More specifically, your non-investment income will be considered first, with your investment income coming after. So, if your non-capital gains income comes in below your status’ next threshold, but the investment income pushes it past that, then your capital gains will be divided between each bracket accordingly.

Here are some examples of long-term capital gains tax calculations.

Long-Term Capital Gains Tax Examples

Which States Levy Capital Gains Taxes?

The majority of U.S. states charge a state-level capital gains tax. That means you may owe both state and federal taxes on your investment income. However, some states allow you to deduct your federal taxes from your taxable state income. This should help you minimize your state taxes if your state offers that deduction.

There are only eight states in the U.S. that don’t have a capital gains tax: Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas and Wyoming. All 42 other states have some kind of capital gains tax, as does Washington, D.C. For 2025, capital gains tax rates in these states range from 2.5% in North Dakota up to 14.4% in California.

How the Capital Gains Tax Interacts With Other Taxes

Beyond capital gains taxes, if you’re a high-income individual with a large portion of your income coming from investing, you may encounter the net investment income tax (NIIT). This 3.8% tax applies to individuals who have capital gains with a modified adjusted gross income (MAGI) above certain thresholds. 

Here’s a breakdown of the NIIT MAGI limits by tax status.

Net Investment Income Tax (NIIT) Thresholds

The alternative minimum tax (AMT) can also come into play with capital gains. This is essentially a separate tax system that runs parallel to traditional income tax brackets and rules. It’s a much more inclusive system, meaning it taxes more types of income and gets rid of some deductions and credits. It was created in the 1960s as a way to ensure that more taxes are paid by those who take heavy advantage of tax-free forms of income.

One situation where AMT can apply is when you have high capital gains for the tax year. If your total income (wages and capital gains) surpasses prescribed AMT exemptions for the current tax year, then you’ll need to perform an AMT calculation. 

For 2026, the AMT exemptions are as follows:

• Single: $90,100
• Married, filing jointly: $140,200

Another situation that can come into play is if you have unrealized capital gains from exercised qualified incentive stock options (ISOs). These are typically available to employees of companies where the company allows them to buy stocks at a cheaper price. Despite the fact that you may have yet to sell the exercised ISOs, you’ve received a profit by virtue of the lower costs.

So, let’s say you’ve triggered the AMT through one of the two means above. In that situation, you’ll then need to run your taxes through the AMT, as well as the traditional income tax system. You can do this by using IRS Form 6251. If your AMT comes out lower than your normal income tax return, then you won’t own anything extra. But if your AMT is higher than the taxes on your normal income tax return, then you’ll have to pay both your original taxes and the difference, up to the AMT.

Planning Ahead for Capital Gains Taxes

If you’re trying to minimize your capital gains taxes, the best thing you can do is hold onto your assets for at least one year. While this might not always be possible, especially with the ebbs and flows of the stock market, you’ll receive much more preferential tax treatment if you can manage to do so.

Another way to avoid capital gains taxes is to utilize any capital losses you may have for the tax year. If you sell some investments for a gain and others for a loss, but overall you come out on top, then you can deduct your losses from your gains to minimize your capital gains. This will help you decrease your taxable capital gains for the year while also softening the blow of losing money. Additionally, if your capital losses outweigh your capital gains, you can deduct a certain amount from your taxable income, up to either the lesser of $3,000 or your total net capital losses ($1,500 if married filing separately).

If you’re saving for retirement and want to avoid capital gains taxes, make sure to use whatever tax-deferred accounts you have available to you. This could include an individual retirement account (IRA) or an employer-sponsored 401(k). By using these, you defer your taxes until retirement, though they will incur ordinary income taxes. However, because your non-investment income will likely be low when you retire, those taxes should be fairly manageable.

Capital Gains Tax Deductions and Special Circumstances

When you sell your own home, you may be subject to capital gains taxes (though things work a bit differently with real estate investments). For instance, if you’re single, you can make up to $250,000 profit on your home without incurring capital gains taxes. For married couples filing jointly, this exclusion goes up to $500,000. If you exceed those marks, however, you’ll be subject to some capital gains taxes.

Collectibles are another area where capital gains taxes work a bit differently than they do with standard investments. All collectibles, like art, jewelry, baseball cards and more, are taxed at a flat 28% rate.

Capital Gains Taxes During Major Life Transitions

Capital gains rules work differently when assets move from one owner to another as a result of  life events, rather than through a typical sale. Divorce, inheritance, gifting and death often transfer ownership without triggering immediate tax, but they can change how future gains are calculated. The key issue is how these transfers affect cost basis and holding periods, since those factors determine how much of a future sale is taxable. As a result, the tax outcome may look very different from a standard buy-and-sell transaction.

Inherited assets receive special treatment under federal tax law. In many cases, the beneficiary’s cost basis is adjusted to the asset’s fair market value at the time of the original owner’s death. This adjustment can significantly limit capital gains if the asset is sold later, particularly when it has appreciated over many years. However, this treatment does not apply universally. Assets received as lifetime gifts, property held in certain trusts or accounts that do not qualify for basis adjustment may retain the original owner’s basis instead.

Divorce-related transfers raise separate capital gains considerations. Moving assets between spouses as part of a divorce decree is generally not treated as a taxable event. Instead, the recipient steps into the original owner’s tax position. If the asset is sold later, capital gains are calculated using the prior cost basis, not the value at the time of divorce. This can affect homes, brokerage accounts and business interests where appreciation occurred before the transfer.

Capital gains taxes also come into play during retirement transitions and business exits. Funding retirement by selling long-held investments or selling a closely held business can concentrate gains into a short time frame. The year of sale, the assets chosen and the ownership structure all affect the resulting tax exposure. These decisions often shift income across tax years, making timing and asset selection central to managing capital gains during major financial transitions.

Bottom Line

Making money from investments like stocks, stock options and real estate can be beneficial to your financial plans. However, there are many rules surrounding this type of income, with rate differences between short- and long-term capital gains being one of the most obvious. You can never plan ahead too much, simply to ensure you don’t get hit hard come tax time each year.

Tips for Capital Gains Tax Planning

• When you start making money from investments, you’ll need to start planning for capital gains taxes. If you’d rather leave that to a professional, a financial advisor could be a worthwhile partnership. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• Beyond capital gains taxes, you’ll want to be knowledgeable about all versions of investment income. Check out SmartAsset’s guide to investment income to start learning.

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