Capital gains: how timing and character decide the tax

What counts as a capital gain

A capital gain is the profit when you sell a capital asset for more than its adjusted basis — generally what it cost you, with adjustments (IRS Topic 409). Stocks, bonds and a home you live in are typical capital assets (Topic 409), and cryptocurrency and other digital assets are treated as property (Publication 550).

Some things are specifically not capital assets. Inventory is one. So is property used in a business that is depreciable or is real estate (IRC §1221) — a rental building, equipment, business vehicles. Those have their own set of rules, covered under “Business property” below, and in practice they often end up taxed like capital gains anyway.

Timing: short-term versus long-term

The single biggest factor is how long you owned the asset. A gain on an asset held more than one year is long-term; one year or less is short-term (IRC §1222). Short-term gains are taxed at your ordinary income tax rates, the same as wages (IRS Topic 409).

Counting matters when a sale is close to the line. According to IRS Publication 550, you begin counting on the day after you acquired the property, and the day you sell is included. For stock and securities traded on an exchange, you use the trade dates, not the settlement dates. So shares bought on March 10 of one year need to be sold on or after March 11 of the next year to be long-term.

Some property carries a holding period with it:

• Inherited property is treated as held for more than one year, however soon you sell it (IRC §1223(9)).
• Gifted property generally takes over the giver’s holding period along with their basis (Publication 550).
• Replacement shares after a wash sale include the holding period of the shares you sold (Publication 550; see below).

The long-term rates, and why other income matters

Long-term capital gains and qualified dividends are taxed at 0%, 15% or 20%. Which rate applies depends on your taxable income — not on the size of the gain alone. The dollar breakpoints are adjusted for inflation each year:

Gains sit on top of your other income. The IRS worksheet that computes the tax starts from total taxable income and fills the 0% band with your ordinary income first (Form 1040 instructions (2025), Qualified Dividends and Capital Gain Tax Worksheet). Only what’s left of the 0% band is available for gains. So, applying that method to the 2026 figures above, a single filer with $40,000 of taxable income (after deductions) from wages has only $9,450 of room at 0% ($49,450 − $40,000); a gain beyond that is taxed at 15%.

That’s why the year of a sale matters so much. A gain realized in a year with little other income — a gap between jobs, early retirement, a sabbatical — can fall largely into the 0% or 15% band, where the same gain in a high-earning year might reach 20% and trigger the 3.8% tax below.

Character: gains with their own maximum rates

Not every long-term gain gets the 0/15/20% rates. Two common exceptions are set in IRC §1(h):

• Depreciation on real estate — up to 25%. When you sell a rental or other depreciable real property at a gain, the part of the gain that reflects depreciation you took (called “unrecaptured section 1250 gain”) is taxed at a maximum of 25%. The rest of the gain gets the usual long-term rates.
• Collectibles — up to 28%. Art, rugs, antiques, metals, gems, stamps, coins and similar items (IRC §408(m)(2), as applied by §1(h)(5)). The part of eligible gain on qualified small business stock under §1202 that a 50% or 75% exclusion leaves taxable is also in the 28% group (IRC §1(h)(7); Topic 409).

These are maximums. If your ordinary rate is lower, the lower rate applies (IRC §1(h)(1); Topic 409).

The 3.8% net investment income tax

On top of the regular capital gains rates, a 3.8% net investment income tax applies to the smaller of your net investment income or the amount by which your modified adjusted gross income exceeds a threshold (IRC §1411):

• $250,000 married filing jointly or qualifying surviving spouse
• $125,000 married filing separately
• $200,000 for everyone else

These thresholds are fixed in the statute and, as the IRS notes, not indexed for inflation — so more people cross them every year. Capital gains are generally investment income for this purpose, and gain on rental property often is too. Gain on property used in a business you actively run is generally not. Gain on selling an interest in a partnership or S corporation counts to the extent you were a passive owner, so it depends on how involved you were (IRC §1411(c)(1)(A)(iii); IRS NIIT Q&A).

Losses: offsetting, the $3,000 limit and carryovers

Gains and losses are netted. Short-term gains and losses are combined, long-term gains and losses are combined, and then the two results are combined (Publication 550).

If you end the year with a net loss, you can deduct up to $3,000 of it against other income ($1,500 if married filing separately) (IRC §1211(b)). That figure is set in the statute and has not changed with inflation. Anything above it carries forward to future years until it is used up, keeping its short- or long-term character (IRC §1212(b); Publication 550). A loss a person hasn’t used by death can be deducted only on their final income tax return; the estate cannot deduct it or carry it over (Publication 550).

Wash sales: selling at a loss and buying back

If you sell stock or securities at a loss and buy substantially identical stock or securities within 30 days before or after the sale, the loss is disallowed for now (IRC §1091). It isn’t lost: it’s added to the basis of the replacement shares, and their holding period includes the old shares’ (Publication 550). That window is 61 days in total, counting the sale date.

• Buying back in an IRA. The IRS has ruled that when the replacement shares are bought in an IRA or Roth IRA, the loss is disallowed and the IRA’s basis is not increased by it (Rev. Rul. 2008-5) — so, in effect, the loss is not recovered later through the replacement shares.
• A spouse or a corporation you control buying the shares also counts as a wash sale (Publication 550).
• Cryptocurrency. The statute applies to “stock or securities” (IRC §1091(a)). The IRS treats digital assets as property (Publication 550), and its Schedule D instructions say the rule generally applies to digital assets that are also stock or securities for tax purposes. Whether a given token is a security can be a real question, so how the rule applies to a particular holding may be unsettled.

Inherited and gifted property

Inherited: basis is generally the fair market value on the date of death (IRC §1014) — often called a “step-up.” Appreciation during the decedent’s lifetime is generally not taxed as a capital gain. There are exceptions. Items that are a right to receive income in respect of a decedent don’t get this treatment, notably retirement accounts like traditional IRAs, which are taxed as the money comes out (IRC §1014(c)). And appreciated property the decedent received as a gift within one year of death has its own rule (IRC §1014(e)).

Gifted: you generally take over the giver’s basis (IRC §1015). If the property was worth less than the giver’s basis at the time of the gift, a special rule applies: for a loss you use the lower value, so a sale between the two figures produces neither gain nor loss (Publication 550).

Whether to give appreciated property now or leave it through an estate is a planning question where these two rules pull in opposite directions.

Spreading a gain: installment sales

When you sell property and receive at least one payment after the year of sale, the installment method generally lets you report the gain as the payments come in, in proportion to the profit in each payment (IRC §453). Spreading a gain across years can keep more of it in lower brackets.

• It isn’t available for publicly traded stock or securities, or for inventory and dealer sales (IRC §453(b)(2) and (k)(2); Publication 550).
• Depreciation recapture that is taxed as ordinary income is all taxable in the year of sale, even if you haven’t received the cash yet (IRC §453(i)).
• A seller can elect out and report the whole gain in the year of sale (IRC §453(d)).
• You take on the buyer’s credit risk. The tax treatment is only one part of whether seller financing makes sense.

Business property and real estate

Depreciable business property and business real estate held more than one year fall under IRC §1231. In a year when these gains exceed these losses, the net is treated as long-term capital gain. In a year when losses exceed gains, the net is an ordinary loss, not a capital loss, so the $3,000 capital-loss limit doesn’t apply to it (IRC §1231(a)(2)) — though other limits, such as the passive-loss and excess business loss rules, still can.

Two catches. First, depreciation on equipment and similar property is recaptured as ordinary income before any of this applies (IRC §1245(a)(1)). Second, a net §1231 gain is treated as ordinary income to the extent of net §1231 losses deducted as ordinary in the five preceding years (IRC §1231(c)). So the order of gain years and loss years can matter.

Real estate investors often defer these gains entirely with a like-kind exchange — see our guide to 1031 exchanges.

Selling your home

If you owned and lived in a home as your main residence for at least two of the five years before the sale, you can generally exclude up to $250,000 of gain, or $500,000 for a married couple filing jointly who meet the conditions (IRC §121). The two years don’t have to be continuous (Publication 523). These amounts are fixed in the statute, which does not adjust them for inflation. A partial exclusion is available when a sale is made because of a change in place of employment, health or other unforeseen circumstances and the two-year tests aren’t met (IRC §121(c)), and a home that was also used as a rental has further rules (IRC §121(b)(5)).

Common questions

Sources

• IRS Publication 550 — Investment income and expenses — checked September 30, 2026
• IRS Topic 409 — Capital gains and losses — checked September 30, 2026
• Rev. Proc. 2025-32 — 2026 inflation adjustments — checked September 30, 2026
• Rev. Proc. 2024-40 — 2025 inflation adjustments — checked September 30, 2026
• IRS — Instructions for Schedule D (Form 1040) — checked September 30, 2026
• IRC §1(h) — maximum capital gains rates — checked September 30, 2026
• IRC §1411 and IRS Q&A — net investment income tax — checked September 30, 2026
• IRC §1091 — wash sales — checked September 30, 2026
• IRC §453 — installment method — checked September 30, 2026
• IRC §1231 and IRS Publication 544 — sales of business property — checked September 30, 2026
• IRS Publication 523 — Selling your home — checked September 30, 2026
• IRS — Instructions for Form 1040 (2025), Qualified Dividends and Capital Gain Tax Worksheet — checked September 30, 2026
• Rev. Rul. 2008-5 — wash sale with replacement shares bought in an IRA — checked September 30, 2026
• IRC §121 — exclusion of gain from sale of principal residence — checked September 30, 2026
• IRC §408(m) — collectibles — checked September 30, 2026
• IRC §1014 — basis of property acquired from a decedent — checked September 30, 2026
• IRC §1015 — basis of property acquired by gift — checked September 30, 2026
• IRC §1061 — partnership interests held in connection with performance of services — checked September 30, 2026
• IRC §1211 — limitation on capital losses — checked September 30, 2026
• IRC §1212 — capital loss carryovers — checked September 30, 2026
• IRC §1221 — capital asset defined — checked September 30, 2026
• IRC §1222 — short-term and long-term — checked September 30, 2026
• IRC §1223 — holding period of property — checked September 30, 2026
• IRC §1231 — property used in the trade or business — checked September 30, 2026
• IRC §1245 — gain from dispositions of certain depreciable property — checked September 30, 2026
• IRC §1411 — net investment income tax — checked September 30, 2026