When you sell an investment, the taxable profit is the sale price minus your cost basis, generally what you paid including reinvested dividends. That profit is a capital gain, and how hard it is taxed depends almost entirely on patience. Gains on assets held one year or less are short-term, piled on top of your wages and taxed at ordinary rates. Hold for more than a year and the gain is long-term, taxed under a separate, gentler rate schedule. Nothing about the investment changes at the one-year mark; only the tax treatment does, which is why holding periods are worth tracking.
Capital Gains Tax
Capital gains tax is the tax on profit from selling an asset for more than you paid. Assets held over one year get preferential long-term rates of 0%, 15%, or 20%; assets held a year or less are taxed as ordinary income.
Reviewed by
Steven Fox, CFP®, EA
Updated
Quick Summary
- You owe tax only when you sell; unrealized gains on paper are not taxed while you hold.
- The one-year line is everything--hold longer and the gain becomes long-term, taxed at 0%, 15%, or 20% instead of ordinary rates up to 37%.
- For 2026, the 0% long-term rate covers taxable income up to $49,450 (single) or $98,900 (married filing jointly).
- High earners add the 3.8% net investment income tax (NIIT) above $200,000 MAGI single / $250,000 joint.
- Inherited assets receive a step-up in basis, wiping out the lifetime gain for heirs.
Definition
Advanced Explanation
For 2026, the long-term rate brackets run on taxable income. The 0% rate applies up to $49,450 for single filers and $98,900 for married filing jointly; the 15% rate applies up to $545,500 and $613,700 respectively; above that, 20%. Two add-ons matter. The net investment income tax (NIIT) layers 3.8% on investment income once modified adjusted gross income exceeds $200,000 (single) or $250,000 (joint), so a high earner's true top long-term rate is 23.8%. And short-term gains simply join your ordinary income at rates up to 37%, which can nearly double the tax on a sale made at month eleven versus month thirteen.
The 0% bracket is not a curiosity; it is a planning tool. In lower-income years--early retirement before Social Security and RMDs begin is the classic window--taxpayers can deliberately realize long-term gains up to the top of the 0% bracket, an approach called gain harvesting, paying nothing federally and resetting their basis higher.
Death changes the arithmetic entirely. Inherited assets receive a step-up in basis to their value at the owner's death, so the gain accrued over a lifetime is never taxed as capital gain to anyone. That single rule explains a great deal of elder financial planning, including the reluctance to sell highly appreciated assets late in life and the preference for donating appreciated shares rather than cash to charity.
Used in a Sentence
“Because selling in November would have made the gain short-term, Wes waited until the following February to sell his fund shares, cutting the federal rate on his profit from 32% to 15%.”
How It Works
A hypothetical example. Nadia, a single filer, bought fund shares for $30,000 and sells them for $50,000 after holding three years, a $20,000 long-term gain. Her wage income puts her taxable income, including the gain, around $140,000, inside the 15% long-term bracket, so the federal tax on the sale is about $3,000. Had she sold eleven months after buying, the same $20,000 would have been short-term, taxed at her 24% ordinary rate: $4,800.
Contrast her retired neighbor Al, also single, whose 2026 taxable income is $40,000 including a $5,000 long-term gain he realized on purpose. His total sits below the $49,450 top of the 0% bracket, so his federal capital gains tax is zero, and his basis in the repurchased shares resets higher. State income tax, where applicable, is a separate layer in both cases.
Pros and Cons
Pros
- Long-term rates are meaningfully lower than ordinary income rates, a built-in reward for patience.
- Tax is due only on sale, so buy-and-hold investors control the timing of the bill.
- The 0% bracket allows deliberate, tax-free gain harvesting in lower-income years.
- Losses net against gains, making downturns partially recoverable at tax time.
Cons
- The tax can anchor investors to concentrated positions they should sell, letting tax strategy override risk management.
- Short-term trading forfeits the preferential rates entirely.
- NIIT, state taxes, and interactions with other income make the true rate on a big sale easy to underestimate.
- Mutual funds can distribute taxable gains you did nothing to trigger.
People Also Asked
Answers to the most frequently asked questions.
What is the difference between short-term and long-term capital gains?
The holding period. Sell an asset you have held for one year or less and the gain is short-term, taxed at the same rates as your salary, up to 37% federally. Hold it more than one year and the gain is long-term, taxed at 0%, 15%, or 20% depending on taxable income. For someone in the middle brackets, waiting past the one-year mark roughly cuts the federal rate on the gain in half.
How can a capital gain be taxed at 0%?
The long-term schedule starts at zero. For 2026, long-term gains are federally untaxed to the extent your total taxable income stays under $49,450 (single) or $98,900 (married filing jointly). Retirees and others in low-income years can intentionally realize gains up to that line each year, resetting basis higher for free. State tax may still apply, and the realized gain itself counts toward the threshold.
What is the net investment income tax (NIIT)?
An extra 3.8% federal tax on investment income, including capital gains, for taxpayers with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly). It stacks on top of the regular capital gains rate, so a top-bracket seller pays 23.8% federally on long-term gains. The thresholds are not indexed for inflation, so more taxpayers cross them each year.
Do heirs pay capital gains tax on inherited investments?
Generally not on the gain that accrued before death. Inherited assets receive a step-up in basis to date-of-death value, so an heir who sells promptly owes little or nothing. A $500,000 position bought decades ago for $50,000 passes with the $450,000 gain erased for income tax purposes. This rule was left unchanged by the 2025 tax law and is central to decisions about which assets to spend, gift, or hold late in life.
Can I avoid capital gains tax by not selling?
Deferring is genuinely powerful: no sale, no tax, and the money compounds untaxed in the meantime. But avoidance has limits. Mutual funds can pass through taxable distributions, rebalancing sometimes requires sales, and concentration risk can make holding more dangerous than the tax is expensive. Sequencing sales across years and brackets is a classic project for a fee-only or advice-only planner with tax expertise.
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