What Is Capital Gains Tax?

If you ever find yourself hanging out with investors or accountants and you hear capital gains (or capital gains tax) come up in conversation, buckle up—because if there’s anything those guys and gals like to talk about, it’s capital gains. That’s how they spell party.

You probably already know about the money Uncle Sam takes out of each paycheck for income taxes. But what are capital gains? And how are they taxed? Let’s cut to the chase.  

What Are Capital Gains?

To understand capital gains taxes, first we have to define capital gains. When you sell an asset (such as stock or real estate) for more money than you paid to buy it, the difference is usually called a profit. But to the tax man, that profit goes by a fancy name: capital gains.

And guess what? The government claims a slice of that profit by charging a capital gains tax simply because . . . well, it’s the government, and that’s what it does best. But in all seriousness, the capital gains tax exists mainly for two reasons: to provide revenue for the government and to prevent tax avoidance loopholes (sometimes there is a method to the madness, even at the IRS).

What Assets Are Subject to Capital Gains Tax?

When people talk about capital gains, they usually mean profits from investments in assets like stocks, bonds and real estate.¹ But the IRS can ding you for capital gains tax on a whole lot more:

• Businesses, in part or whole
• Collectibles (art, antiques, coins)
• Other types of assets (futures, options, partnership interests)²

For the record, the IRS technically considers cryptocurrency an asset too, but we freakin’ do not. (And now you know.) Listen, it literally pays to do your homework before you sell any of this stuff—especially if you’ve owned it for one year or less. Read on for more about that time frame.

How Does Capital Gains Tax Work?

Okay, let’s say you buy a piece of land for $125,000. Later, you sell that same piece of land for $175,000. The $50,000 profit you made on the sale is a capital gain. You bought an asset, the asset increased in value, and you sold it for more than you paid for it. It’s a win, right?

Not so fast. Like a nosy neighbor, the IRS knows exactly how to get all up in your business. You’ll most likely owe tax on that capital gain. How much you’ll have to fork over to Uncle Sam depends on a few different factors. It can get complicated, but hang with us and we’ll guide you through it.

How Much Is the Capital Gains Tax?

In most cases, your capital gains tax rate depends on three things:

• How long you owned the asset
• Your taxable income
• Your filing status

There are different tax rates on long-term capital gains (for assets you’ve owned more than a year) and short-term capital gains (for assets you’ve owned one year or less).

Taxes don’t have to overwhelm you. See what’s best for your situation—and services you can trust.

In some cases, the type of asset might play a factor in how it’s taxed. And some capital gains up to a certain amount can even be excluded when you file (the biggest exclusion for most people is their primary residence).³

Long-Term Capital Gains Tax

If you own an asset for more than one year and then decide to sell it for a profit, you have a long-term capital gain. Congrats!

Long-term capital gains are taxed at special rates that are more favorable than those on short-term capital gains. Long-term capital gains tax rates start at 0% and max out at 20% based on your taxable income and filing status. The idea behind these better rates is to encourage long-term investing, which generally keeps the stock market stable and promotes more economic growth.

Here’s a look at the long-term capital gains tax rate for tax years 2024 and 2025: 

 

2024 Long-Term Capital Gains Tax Rate (for Taxes Due in 2025)

Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
0%	$0–47,025	$0–94,050	$0–63,000	$0–47,025
15%	$47,025–518,900	$94,050–583,750	$63,000–551,350	$47,025–291,850
20%	Over $518,900	Over $583,750	Over $551,350	Over $291,8504

 

2025 Long-Term Capital Gains Tax Rate (for Taxes Due in 2026)

Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
0%	$0–48,350	$0–96,700	$0–64,750	$0–48,350
15%	$48,350–533,400	$96,700–600,050	$64,750–566,700	$48,350–300,000
20%	Over $533,400	Over $600,050	Over $566,700	Over $300,0005

 

Also, since the IRS loves creating alphabet-soup tax rules, all you high-income earners out there will have to pay an additional 3.8% net investment income tax (NIIT) on your capital gains if your modified adjusted gross income (MAGI) is greater than $200,000 ($250,000 for married filers).⁶

Short-Term Capital Gains Tax

Short-term capital gains are taxed more aggressively than long-term capital gains. If you’ve owned the asset for one year or less (think house flip), the profit from the sale is taxed at your normal personal income tax rate—which could be anywhere from 10–37%.

When you file your taxes, all you need to do is check your federal income tax rate to see how much you owe in taxes for your short-term capital gain. It’s also important to note that the NIIT (3.8%, remember) also applies to short-term capital gains.

How to Avoid Capital Gains Tax

The most important thing you need to know about tax strategy comes straight from Dave Ramsey. In his book The Legacy Journey, he says: “There is absolutely nothing wrong or immoral about using every legal means available to avoid taxes. In fact, I’ll take it a step further. I believe that taking advantage of every legal method of avoiding taxes is actually good stewardship.”

You also need to know that tax law, like social media trends, is subject to change without notice. That’s why you probably should check in with a tax pro about your own situation before doing anything drastic.

Having said all that, here are a few ways you might be able to avoid getting smacked with the capital gains tax.

Long-Term Investing

We love the buy-and-hold investment strategy. That means when you buy an investment, like shares in a mutual fund, you do so with the intention of holding those shares for a long time—no matter what the stock market might be doing on a given day.

It takes a long-term mindset to stick with the buy-and-hold strategy, but you’ll be rewarded with a better capital gains tax rate if you hold your investments more than a year. Hold them any less than that and you’ll pay taxes on your gains at your ordinary income tax rate, which could increase your tax burden by a lot.

Tax-Advantaged Accounts

Tax-advantaged retirement savings accounts like 401(k)s and IRAs allow you to sidestep capital gains altogether with tax-deferred (or tax-free!) growth. Yep, if you purchase assets through a qualified retirement account like a 401(k) or IRA, you won’t have to pay any capital gains taxes at all—woo-hoo!

The idea is that during the growth phase, your retirement savings are shielded from capital gains tax. And with the Roth versions of those plans, you can even get your taxes out of the way up front.

Capital Losses

Sometimes an investment just doesn’t go the way you wanted it to. Instead of the value of the investment going up, it drops like a rock . . . and you wind up taking a loss and selling it for less than you paid. That stinks, but there might be one silver lining to your investing misadventure.

Thanks to a strategy called tax-loss harvesting, you can use those capital losses to offset other capital gains so you pay less in taxes for the year. For example, if you sold one of your investments for a $5,000 gain but sold another investment for a $1,000 loss, you would only pay capital gains tax on the remaining $4,000.   

If you had a really bad year and your capital losses were greater than your capital gains, you could use up to $3,000 of your capital losses per year ($1,500 if married filing separately) to offset ordinary income. Plus, any unused losses could be carried forward to offset future capital gains.⁷

Sound complicated? That’s because it is. You should always talk to your tax pro before you pull the trigger on any tax-loss harvesting strategy.

Primary Residence Exclusion

This is the big one for most people. If you sell your house for a profit, that’s a capital gain. But depending on how long you lived there, your profit may actually be tax-exempt—which is just a fancy way of saying you wouldn’t owe any capital gains on the sale of your home. Pretty nice!

But here’s the thing: It must be your main residence (where you live full time, not the lake house), and you must have lived there for at least two years of the previous five. You can exclude up to $250,000 in capital gains for single filing status or $500,000 for married filing jointly, and you can claim this exemption once every two years.⁸

Charitable Giving

Fun fact: You might be able to donate appreciated assets (mutual funds, real estate or golden idols that belong in a museum, for example) to charity and reduce your capital gains taxes in the process. Not only that, but making a charitable donation also gives you a tax deduction that reduces your taxable income.⁹

For example, let’s say you bought stock for $1,000 and it’s now worth $4,000. Instead of selling it, you could donate that stock to charity. By doing that, you avoid having to pay the capital gains tax altogether—and you can deduct the full $4,000 from your taxable income (only if you itemize your deductions, though).  

That’s like an IRS buy-one-get-one-free offer. And trust us, those are rare.

1031 Exchange

If you own a rental property, you can defer or postpone paying capital gains tax on its sale by taking advantage of a 1031 exchange. This is a tax-deferral provision that allows you to sell a property and reinvest the profit into what the IRS calls a like-kind investment.

In other words, you use the profit to purchase a similar property and—ta-da!—you won’t have to pay capital gains tax until you stop reinvesting your profits. But don’t waste too much time . . . you have to reinvest the money quickly to avoid the capital gains tax.¹⁰

Okay, we’ve covered a lot about tax strategies, so here’s the bottom line: You’ll benefit from having a plan in place before you purchase or sell an asset. And it’s always a great idea to talk through your plans and options with a tax pro.

Make Your Tax Journey Easier

We get it—this is a lot to keep track of. But a tax pro can help you crunch the numbers, no sweat. Our RamseyTrusted^® tax pros are great at helping people figure out how to tackle their taxes.

Not only will they help you prepare your tax return, but they’ll also help you plan for the future. They can walk you through your available options with the capital gains tax and whatever other tax needs you have.

Find your tax pro today!