In the United States, individuals and corporations pay a 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.)
However, taxpayers pay no tax on income covered by deductions: the standard deduction (for 2022: $12,950 for an individual return, $19,400 for heads of households, and $25,900 for a joint return), or more if the taxpayer has over that amount in itemized deductions. Amounts in excess of this are taxed at the rates in the above table.
Separately, the tax on collectibles and certain small business stock is capped at 28%. The tax on 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 are adjusted each year based on the Chained CPI measure of inflation.
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, known as the net investment income tax, on investment income above their threshold, with additional limitations. 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.
Cost basis
The capital gain that is taxed is the excess of the sale price over the cost basis of the asset. The taxpayer reduces the sale price and increases the cost basis (reducing the capital gain on which tax is due) to reflect transaction costs such as brokerage fees, certain legal fees, and the transaction tax on sales.
Depreciation
In contrast, when a business is entitled to a depreciation deduction on an asset used in the business (such as for each year's wear on a piece of machinery), it reduces the cost basis of that asset by that amount, potentially to zero. The reduction in basis occurs whether or not the business claims the depreciation.
If the business then sells the asset for a gain (that is, for more than its adjusted cost basis), this part of the gain is called depreciation recapture. When selling certain real estate, it may be treated as capital gain. When selling equipment, however, depreciation recapture is generally taxed as ordinary income, not capital gain. Further, when selling some kinds of assets, none of the gain qualifies as capital gain.
Other gains in the course of business
If a business develops and sells properties, gains are taxed as business income rather than investment income. The Fifth Circuit Court of Appeals, in Byram v. United States (1983), set out criteria for making this decision and determining whether income qualifies for treatment as a capital gain.