Capital Gains Taxes FAQ

The distinction between short-term and long-term capital gains depends entirely on your holding period - how long you owned the asset before selling. Under IRC Section 1222, this classification determines your applicable tax rate and can result in dramatically different tax consequences.

Short-term capital gains apply to assets held for one year or less. These gains receive no preferential tax treatment and are taxed as ordinary income at your marginal tax rate. For 2024, this means short-term gains could be taxed at rates up to 37% for the highest earners, plus any applicable state income taxes and the Net Investment Income Tax.

Long-term capital gains apply to assets held for more than one year and receive preferential tax rates. For 2024, the long-term capital gains rates are:

• 0% - Single filers with taxable income up to $47,025; married filing jointly up to $94,050
• 15% - Single filers with taxable income from $47,026 to $518,900; married filing jointly from $94,051 to $583,750
• 20% - Single filers with taxable income above $518,900; married filing jointly above $583,750

The holding period begins the day after you acquire the asset (not the purchase date) and ends on the day you sell or exchange it. For example, if you purchase stock on January 15, 2024, you must hold it until at least January 16, 2025, for long-term treatment. Use our capital gains tax calculator to estimate your tax liability.

The Net Investment Income Tax (NIIT) under IRC Section 1411 is an additional 3.8% tax on investment income that affects higher-income taxpayers. Enacted as part of the Affordable Care Act, the NIIT applies to individuals, estates, and trusts with investment income above certain thresholds.

The NIIT applies when your modified adjusted gross income (MAGI) exceeds:

• $200,000 for single filers and heads of household
• $250,000 for married filing jointly and qualifying surviving spouses
• $125,000 for married filing separately

The tax is calculated on the lesser of your net investment income or the amount by which your MAGI exceeds the applicable threshold. Net investment income includes:

• Capital gains from sales of stocks, bonds, mutual funds, and real estate (excluding primary residence exclusion)
• Dividends (both qualified and non-qualified)
• Interest income (excluding tax-exempt municipal bond interest)
• Rental and royalty income
• Passive business income from businesses you don't materially participate in
• Gains from trading financial instruments or commodities

Importantly, NIIT does not apply to wages and self-employment income, distributions from qualified retirement plans (401(k), IRA), tax-exempt interest from municipal bonds, Social Security benefits, or income from businesses in which you materially participate.

For high-income investors, the NIIT effectively increases the top long-term capital gains rate from 20% to 23.8%, and the top short-term rate from 37% to 40.8%. NIIT is calculated on Form 8960 and reported on your tax return.

Cryptocurrency is treated as property (not currency) for federal tax purposes under IRS Notice 2014-21, meaning all general tax principles applicable to property transactions apply to crypto. This classification has significant implications for how crypto gains and losses are taxed.

When you sell, trade, or otherwise dispose of cryptocurrency, you realize a capital gain or loss calculated as the difference between your sale proceeds (fair market value received) and your cost basis (original purchase price plus any transaction fees). The tax rate depends on your holding period:

• Short-term gains: Crypto held one year or less is taxed as ordinary income at your marginal rate (up to 37%)
• Long-term gains: Crypto held more than one year receives preferential rates (0%, 15%, or 20%)

Taxable cryptocurrency events include:

• Selling cryptocurrency for fiat currency (USD, etc.)
• Trading one cryptocurrency for another (e.g., Bitcoin for Ethereum)
• Using cryptocurrency to purchase goods or services
• Receiving cryptocurrency as payment for services (taxed as ordinary income at FMV, plus capital gain/loss on disposition)
• Earning cryptocurrency through mining or staking (ordinary income at FMV when received)
• Receiving airdrops or hard fork tokens (ordinary income at FMV when you gain dominion and control)

Non-taxable events include:

• Buying cryptocurrency with fiat currency and holding it
• Transferring crypto between your own wallets
• Gifting cryptocurrency (though the recipient inherits your basis)

Cryptocurrency losses can offset gains and up to $3,000 of ordinary income annually. Note that the wash sale rule technically doesn't apply to crypto (since it's not a security), though proposed legislation may change this.

Tax-loss harvesting is a strategic investment technique that involves selling securities at a loss to offset capital gains and reduce your overall tax liability. When executed properly, this strategy can defer taxes and convert short-term gains (taxed at higher ordinary income rates) into long-term gains (taxed at preferential rates).

How capital losses offset gains under IRC Section 1211:

• Short-term losses first offset short-term gains
• Long-term losses first offset long-term gains
• If you have net losses in one category, they offset gains in the other category
• Up to $3,000 of net capital losses ($1,500 for married filing separately) can offset ordinary income each year
• Losses exceeding these limits carry forward indefinitely under IRC Section 1212

The wash sale rule limitation: Under IRC Section 1091, you cannot claim a tax loss if you purchase "substantially identical" securities within 30 days before or after the sale. This 61-day window (30 days before, the sale date, and 30 days after) prevents investors from immediately repurchasing the same investment. Substantially identical generally means the same stock or very similar mutual funds/ETFs tracking the same index.

Effective tax-loss harvesting strategies:

• Replace sold securities with similar but not substantially identical investments (e.g., sell S&P 500 fund, buy total market fund)
• Wait 31 days before repurchasing the original security if you want to maintain that specific position
• Harvest losses in taxable accounts (retirement accounts don't benefit since gains are already tax-deferred)
• Consider harvesting losses to offset large one-time gains from real estate sales or business exits

California does not offer preferential tax rates for long-term capital gains. Unlike the federal tax system, which taxes long-term gains at reduced rates of 0%, 15%, or 20%, California taxes all capital gains - regardless of holding period - as ordinary income under California Revenue and Taxation Code Section 17041.

This means California capital gains are subject to the state's progressive income tax rates:

• 1% on taxable income up to $10,412 (single) / $20,824 (married filing jointly)
• Rates increase progressively through nine brackets
• 9.3% on income from $66,295-$338,639 (single) / $132,590-$677,278 (MFJ)
• 10.3% on income from $338,639-$406,364 (single) / $677,278-$812,728 (MFJ)
• 11.3% on income from $406,364-$677,275 (single) / $812,728-$1,354,550 (MFJ)
• 12.3% on income above $677,275 (single) / $1,354,550 (MFJ)
• 13.3% on income exceeding $1 million (additional 1% mental health services tax)

For high-income California residents with significant investment gains, the combined federal and state tax burden on long-term capital gains can be substantial:

• Federal: 20% (top bracket) + 3.8% NIIT = 23.8%
• California: Up to 13.3%
• Combined: Up to 37.1%

California does allow capital losses to offset capital gains and provides a $3,000 annual deduction against ordinary income ($1,500 married filing separately), mirroring federal rules. Capital loss carryforwards are also permitted. Use our capital gains tax calculator to estimate combined federal and California taxes.

Under IRC Section 121, you can exclude up to $250,000 of capital gains ($500,000 for married couples filing jointly) from the sale of your primary residence, potentially eliminating your tax liability entirely. This is one of the most valuable tax benefits available to homeowners.

Qualification requirements:

• Ownership test: You must have owned the home for at least two of the five years before the sale
• Use test: You must have lived in the home as your primary residence for at least two of the five years before the sale
• Frequency: You generally cannot have excluded gain from another home sale within the two years before this sale

The two-year ownership and use periods don't need to be consecutive or overlap. For example, you could rent a home for three years, then live in it for two years, and qualify for the exclusion.

Partial exclusions may be available if you fail to meet the full requirements due to:

• Work-related moves (new employment location more than 50 miles from old home)
• Health-related moves (doctor-recommended relocation)
• Unforeseen circumstances (divorce, death, natural disaster, unemployment)

The partial exclusion equals the full exclusion multiplied by the fraction of the two-year requirement you met.

Important considerations:

• Gains exceeding the exclusion are taxed as capital gains (short-term or long-term based on ownership period)
• Depreciation claimed on a home office or rental portion may be recaptured at 25%
• The exclusion doesn't apply to investment or rental properties (though Section 1031 exchanges may defer those gains)
• California conforms to the federal exclusion under Revenue and Taxation Code Section 17152.5

Cost basis is your investment's original value for tax purposes and is crucial for determining your gain or loss when you sell. Accurate basis calculation directly impacts your tax liability - understating basis means overpaying taxes; overstating basis is tax evasion.

Basis for purchased investments (IRC Section 1012):

• Original purchase price
• Plus transaction costs: brokerage commissions, transfer fees, legal fees
• Plus any improvements (for real estate)
• Less depreciation taken (for business/rental property)

Basis for inherited property (IRC Section 1014):

• Generally "stepped up" to fair market value at the decedent's date of death
• This step-up eliminates capital gains accumulated during the decedent's lifetime
• Alternate valuation date (six months after death) may be elected by the estate

Basis for gifted property (IRC Section 1015):

• For gains: Use the donor's adjusted basis (carryover basis)
• For losses: Use the lower of donor's basis or fair market value at time of gift
• If FMV at gift was between donor's basis and sale price, no gain or loss is recognized

Identifying which shares you sold:

• Specific identification: Designate exactly which shares to sell (requires documentation)
• FIFO (First In, First Out): Default method assuming oldest shares sold first
• Average cost: Available for mutual fund shares only

Brokerages report cost basis to the IRS on Form 1099-B for securities purchased after 2011 (2012 for mutual funds, 2014 for fixed income). For older securities, you're responsible for maintaining basis records.

Qualified Opportunity Zones (QOZs) under IRC Section 1400Z, created by the Tax Cuts and Jobs Act of 2017, provide significant capital gains tax benefits for investments in designated low-income communities. There are over 8,700 designated QOZs across all 50 states and U.S. territories.

How QOZ investments work:

1. You realize a capital gain from any source (stocks, real estate, business sale, etc.)
2. Within 180 days of recognizing the gain, you invest some or all of the gain into a Qualified Opportunity Fund (QOF)
3. The QOF must invest at least 90% of its assets in qualified opportunity zone property

Tax benefits of QOZ investments:

• Deferral: The original capital gain is deferred until December 31, 2026, or when you sell the QOF investment, whichever comes first. This allows your original investment capital to work for you tax-free during the deferral period.
• Step-up in basis: Previously, holding the QOF investment for 5-7 years provided partial basis increases, but these benefits expired for new investments after 2019.
• Permanent exclusion: If you hold the QOF investment for at least 10 years, any appreciation in the QOF investment itself is permanently excluded from taxation when you sell. This is the most powerful benefit - all growth within the opportunity zone can be tax-free.

Example: You sell stock for a $1 million gain and invest it in a QOF. You defer the $1 million gain until 2026, when you'll owe tax on it. If the QOF investment grows to $2 million over 10+ years, the additional $1 million of appreciation is completely tax-free when you sell after the 10-year holding period.

QOZ investments are particularly valuable for taxpayers with large one-time capital gains from business sales, real estate transactions, or concentrated stock positions who can commit to long holding periods.