Capital Gains Tax

Capital gains tax is the federal (and often state) tax imposed on the profit realized when a capital asset, such as investment real estate, stocks, or a business, is sold for more than its adjusted basis. For assets held more than one year, the gain is a long-term capital gain taxed at preferential federal rates of 0%, 15%, or 20% depending on the taxpayer's taxable income; assets held one year or less produce short-term gains taxed at ordinary income rates. For real estate, the calculation is more involved because the portion of gain attributable to depreciation previously claimed is recaptured and taxed at a higher rate (unrecaptured Section 1250 gain, up to 25%), and high-income investors may also owe the 3.8% net investment income tax on top of the capital gains rate. Many states impose their own capital gains tax, frequently at ordinary income rates, which can add significantly to the total. The combined federal capital gains, depreciation recapture, net investment income tax, and state tax can claim a substantial share of a long-held property's gain, which is why deferral strategies such as the 1031 exchange, Delaware Statutory Trusts, 721 exchanges, and Opportunity Zone funds are so widely used by real estate investors. The capital gains tax is not assessed until a taxable sale occurs, so deferring or eliminating the recognition event is the foundation of most real estate tax planning. Specific rates and thresholds change with tax law and should be confirmed for the current year.