Long-term capital gain tax

A long-term capital gain is the profit from selling an investment—stock, bond, real estate, or other asset—held longer than one year. These gains receive preferential federal tax treatment: rates are fixed at 0%, 15%, or 20%, far lower than the ordinary income tax rate that can reach 37%. Long-term gains are the most tax-efficient way for most investors to generate returns.

The three brackets

Long-term capital gains are taxed at rates lower than ordinary income. There are three federal brackets:

0% rate. If your taxable income (including the gain) falls below a threshold, you pay no federal tax on the long-term gain. For single filers in 2024, the limit is roughly $47,000; for married couples filing jointly, roughly $94,000. This bracket is often overlooked but extremely valuable: it allows lower-income investors to realise gains tax-free.

15% rate. Most middle- and upper-middle-income earners pay 15% on long-term gains. This is the most common bracket and applies to single filers with income between roughly $47,000 and $518,000, and married couples up to about $1.03 million (2024 figures; thresholds adjust annually for inflation).

20% rate. The highest earners pay 20% on long-term gains. This applies to single filers with income above $518,000 and married couples above $1.03 million, plus an additional 3.8% net investment income tax for the wealthiest.

Why long-term rates matter

The gap between short-term and long-term rates is enormous. An investor in the 24% tax bracket pays 24% on short-term gains but only 15% on long-term gains—a 37.5% reduction in tax. Over a lifetime, this gap compounds. Long-term investing is not just more tax-efficient; it is dramatically more tax-efficient.

The one-year rule

The one-year holding period is measured from the acquisition date to the sale date. If you buy a stock on January 15, you must hold it until January 16 of the following year for the gain to qualify as long-term. Selling one day early locks in the short-term rate. This simple threshold can be worth thousands of dollars.

Interaction with cost basis and harvesting

Your long-term gain depends on your cost basis—your adjusted purchase price. Methods like specific identification, FIFO, or average cost can minimize the gain. Long-term losses can offset long-term gains without limit, and excess long-term losses can offset short-term gains or up to $3,000 of ordinary income per year.

State and local taxes

Long-term gains receive preferential federal treatment, but states and localities often tax them at ordinary rates. New York State imposes 6.85% on capital gains; Los Angeles adds a 4% capital gains tax on the sale of real property. Some states have no income tax at all. Tax-efficient investing often requires considering both federal and state angles.

Lock-in effect

The preferential long-term rate creates a lock-in effect: investors may hold losing positions longer to avoid realising short-term losses, or hold winning positions to obtain long-term rates, even if they would prefer to reallocate. Awareness of this is the first step to mitigating it: a sale that triggers short-term tax may still be rational if it rebalances your asset allocation or reduces diversification risk.

See also