Many types of investing involve some tax implications. The good news is that long-term capital gains generally have a more favorable tax treatment, meaning you can potentially save money on your tax bill. Before you start investing, it’s important to understand the potential tax consequences and how those taxes will affect your overall investment returns.
Understanding long-term capital gains and losses
Anytime you sell an asset, there are potential tax consequences. Capital assets, including stocks, bonds, real estate, and more, can result in either capital gains or losses when sold. If you sell an asset for more than you bought it, you generally have a capital gain, which could be subject to taxation. You’ll pay taxes on the difference between your basis —usually meaning the amount you purchased the asset for — and the price when you sell it.
Meanwhile, when you sell an asset for less than you bought it, you have a capital loss, which can help you reduce your tax liability.
Capital gains can be either long-term or short-term, depending on how long you hold the asset. Assets held for one year or less are subject to short-term capital gains taxes, while assets held for longer than one year are subject to long-term capital gains taxes. Long-term capital gains are typically taxed at lower rates, meaning there may be a benefit to holding onto your assets for longer before you sell them.
Short-term capital gains are taxed at the same rate as your ordinary income. Meanwhile, long-term gains are taxed at either 0%, 15%, or 20%. The rate you pay is based on your taxable income. Just like with ordinary income tax rates, the higher your income, the higher your long-term capital gains tax rate.
While the standard long-term capital gains tax rates apply to most assets, there are a few exceptions. First, and perhaps most relevant for most Americans, is the capital gains tax exemption for selling a home. When you sell a home, you can exclude $250,000 of your gain (or $500,000 for a married couple) if you’ve owned and lived in the home for at least two of the past five years.
Here are a few other assets that may have different capital gains rules, along with their maximum capital gains tax rates:
Section 1202 small business stock: maximum 28% rate
Collectibles (including coins or art): maximum 28% rate
Unrecaptured section 1250 gain from selling section 1250 real property: maximum 25% rate
Just like you’ll pay taxes on your capital gains, you can also save on taxes with your capital losses. First, you can use your capital losses to offset your capital gains. For example, if you have a $100 capital gain on one asset and a $100 capital loss on another, the two will offset each other, and you won’t owe any taxes.
The IRS also allows you to claim up to $3,000 in losses that exceed your capital gains Finally, you can carry forward your unused capital losses to help offset capital gains in future years.
Read more: What are short-term capital gains taxes?
Examples of long-term capital gains
To gain a greater understanding of long-term capital gains taxes, it can be helpful to demonstrate through an example.
First, let’s compare the difference between short-term and long-term capital gains. Suppose Mary and Bob both purchased 500 shares of stock for a price of $25 per share, a total price of $12,500. Both decide to sell the stock once the stock reaches $30 per share, resulting in a $5 per share gain — that’s a total of $2,500.
The key difference is that Mary only owned the stock for nine months, while Bob owned the stock for more than one year. As a result, Mary will pay short-term capital gains taxes, while Bob will pay long-term capital gains taxes.
Let’s say both Mary and Bob have an income of $100,000 per year. Mary’s income falls into the 24% tax bracket, and because her gains are taxed at her ordinary income tax rate, she’ll pay $600 in taxes on her $2,500 gain. Meanwhile, because Bob held his stock for more than one year, he’ll pay tax on long-term capital gains. Bob’s income qualifies him to use the 15% long-term capital gains tax rate, meaning he’ll pay just $375 in taxes. That’s a savings of $225 for Bob just for holding his stock for a few more months.
Of course, there are all sorts of variations as to how these taxes could apply. For example, if either Mary or Bob had an asset in their portfolio they could sell for a loss, they could use a strategy called tax-loss harvesting. In this strategy, they sell the losing asset and use that capital loss to offset their capital gains, therefore reducing their tax liability.
These taxes could also apply differently depending on the type of asset. Because Mary held her asset for less than one year, she will pay her ordinary income tax rate no matter the asset type, even if it’s her home. Bob, on the other hand, could be subject to one of the long-term capital gains tax exceptions we’ve already discussed.
Advantages of long-term capital gains
Holding an asset for more than one year before selling it has a clear financial benefit. Taxpayers in every tax bracket will enjoy a lower long-term capital gains tax rate.
For example, a taxpayer filing under a Single filing status in 2023 with an income lower than $44,625 would pay 0% on long-term capital gains included in that income but could pay as much as 12% on short-term capital gains included in that same income. On the other end of the spectrum, a Single filer earning more than $518,901 in 2024 would pay just 20% in capital gains taxes, while their short-term capital gains rate could be as high as 37%.
This tax savings doesn’t just benefit investors in the current year. If you choose to reinvest your gains, the savings could allow you to purchase more assets, therefore having a major impact on your long-term investment returns.
Of course, the benefits of long-term capital gains don’t necessarily outweigh the benefits of short-term investing for some people. Day traders and other active investors make money by taking advantage of short-term shifts in the market. This strategy involves holding assets for much shorter periods, so it is subject to short-term capital gains taxes. If someone can make money from this strategy, they might decide it’s worth it to pass up on the long-term capital gains tax savings.
Of course, most investors aren’t — and likely shouldn’t be — day trading. Instead, the best long-term investing strategy tends to involve buying a diversified portfolio and holding assets for a long period. Not only is this strategy generally considered more effective in helping someone reach their long-term goals, but it may also provide optimal tax results.
Read more: How to avoid capital gains tax
Solid planning for long-term capital gains
Strategic planning is an important step in helping to reduce your investment taxes and maximize your long-term wealth growth. First, it’s important to track your holding periods and basis for investments to ensure that when you sell assets, you’re able to optimize your outcomes. Luckily, your brokerage firm can assist you in this effort.
You may also consider working with a financial professional who can help you build an optimized portfolio that best helps you reach your financial goals while reducing your tax liability along the way.
Long-term capital gains tax rates 2024
Long-term capital gains are taxed at three different rates: 0%, 15%, or 20%. The amount you’ll pay depends on your taxable income and tax filing status.1
As with other taxes, the IRS adjusts the income ranges for capital gains taxes each year to account for inflation. The table below shows the capital gains tax brackets for tax year 2024:
2024 long-term capital gains tax rates | ||||
Capital gains tax rate | Single | Married filing separately | Married filing jointly | Head of household |
0% | $0 to $47,025 | $0 to $47,025 | $0 to $94,050 | $0 to $63,000 |
15% | $47,026 to $518,900 | $47,026 to $291,850 | $94,051 to $583,750 | $63,001 to $551,350 |
20% | $518,901 or more | $291,851 or more | $583,751 or more | $551,351 or more |
Our take
Holding your investments for more than one year can help you leverage the lower long-term capital gains tax rates and keep more of your investment returns. This one simple change can potentially help you save hundreds — or even thousands — of dollars in capital gains taxes.
Of course, taxes shouldn’t be your only consideration when investing. It’s also important to consider your investment goals, risk tolerance, time horizon, and the current market conditions when planning your investment moves.
It’s also worth acknowledging just how complex these decisions can be. If you don’t feel comfortable or qualified to direct your own investments, especially as it relates to the tax consequences, consider seeking professional guidance. A financial professional can offer insight on your unique situation.
