How Capital Gains Tax Works
Capital gains tax is levied on the profit from selling an investment or asset for more than you paid for it. The tax rate depends on how long you held the asset: short-term gains (held one year or less) are taxed as ordinary income at your marginal tax rate (up to 37%), while long-term gains (held more than one year) receive preferential rates of 0%, 15%, or 20% depending on your income. This favorable treatment of long-term gains incentivizes patient, long-term investing and is one of the most significant tax planning opportunities available to investors.
In addition to the federal capital gains rate, high-income investors may owe the 3.8% Net Investment Income Tax (NIIT) on investment income when their modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). Some states also tax capital gains, either at the same rate as ordinary income or at a separate rate. Understanding these layers of taxation helps you plan asset sales strategically to minimize your total tax burden.
Single filers with taxable income under approximately $47,025 (including the capital gain) pay 0% federal tax on long-term capital gains. A married couple filing jointly pays 0% on gains up to about $94,050 in total taxable income. This is a powerful planning opportunity, especially in early retirement years before Social Security begins.
Capital Gains Tax Rates (2026)
| Rate | Single | Married Filing Jointly |
|---|---|---|
| 0% | $0-$47,025 | $0-$94,050 |
| 15% | $47,026-$518,900 | $94,051-$583,750 |
| 20% | Over $518,900 | Over $583,750 |
| 3.8% NIIT | MAGI over $200,000 | MAGI over $250,000 |
- 1Capital gain: $25,000 - $10,000 = $15,000
- 2Total taxable income (with gain): $75,000 + $15,000 = $90,000
- 3Long-term capital gains rate at this income: 15%
- 4Federal capital gains tax: $15,000 × 15% = $2,250
- 5NIIT: Not applicable (MAGI under $200,000)
- 6After-tax proceeds: $25,000 - $2,250 = $22,750
- 7If sold short-term (held < 1 year): taxed at 22% = $3,300
Capital Gains Tax Reduction Strategies
Minimize Capital Gains Taxes
Canadian Capital Gains Tax
In Canada, only 50% of capital gains are included in taxable income (the inclusion rate), effectively halving the tax rate. For example, a $15,000 capital gain means $7,500 is added to taxable income and taxed at your marginal rate. At a 30% marginal rate, the tax on a $15,000 gain is $2,250 (effective rate of 15%). The 2024 federal budget proposed increasing the inclusion rate to 66.7% for gains above $250,000 annually. Capital gains on a principal residence are completely tax-exempt in Canada, a significant advantage for homeowners. Gains within RRSP and TFSA accounts are sheltered from capital gains tax.
The IRS wash sale rule prevents you from claiming a capital loss deduction if you buy the same or substantially identical security within 30 days before or after the sale. If you violate this rule, the loss is disallowed and added to the cost basis of the new purchase. Plan your tax-loss harvesting carefully to avoid triggering the wash sale rule.