Capital Gains Tax, Its Rates and Impact

Should Investment Income Be Taxed Less than Employment Income?

hedge fund managers talking
••• You may be paying more in taxes than these hedge fund managers. Laurence Mouton/Getty Images

The capital gains tax is a government fee on the profit made from selling something you own. A capital gain is calculated as the total sale price minus the original cost of the property. A capital loss is when you sell it for less than you bought it for. Some capital losses can be deducted on your tax return. That leads to a lower tax payment.

Short-Term Versus Long-Term Capital Gains

Short-term capital gains or losses occur when you've owned the property for a year or less.

 Long-term capital gains or losses occur if you sell it after owning it longer than a year.

Capital Gains Tax Rate

The federal government taxes all capital gains. It taxes short-term capital gains at a higher rate than long-term capital gains. This is to discourage short-term trading, which can increase dangerous volatility.

In 2013, the Affordable Care Act raised rates on long-term capital gains. It applies to singles who make more than $200,000 a year, married couples filing jointly who earn more than $250,000 jointly, and married couples filing separately who earn more than $125,000 a year. They must pay an extra 3.8 percent tax on the lesser of (a) investment income such as dividends and capital gains or (b) adjusted gross income that is above the threshold.

The Obamacare tax also applies to capital gains from selling a home or other real estate for personal use for those earning above the threshold.

Also, capital gains must be greater than $250,000 (singles) or $500,000 (married couples).

Short-term capital gains tax rate. All short-term capital gains are taxed at the regular income tax rate. From a tax perspective, it's usually better to hold onto investments for more than a year.

Long-term capital gains tax rate. The tax rate paid on most capital gains depends on the income tax bracket: 

  • Those in the 10 percent and 15 percent income tax brackets pay no capital gains tax.
  • Those in the top income bracket pay 20 percent. In 2017, it's 39.6 percent. Trump's tax act changes the top rate to 37 percent in 2018-2025.
  • Everyone else pays a 15 percent tax on capital gains.  

Long-term capital gains on collectibles, such as stamps, coins, and precious metals, are taxed at 28 percent. 

Taxpayers can declare capital losses on financial assets, such as mutual fundsstocks, or bonds. They can declare losses on hard assets, such as real estate, precious metals, or collectibles if they weren't for personal use. 

Those who have long-term gains in excess of long-term losses have a net capital gain. But that's only to the extent the net long-term capital gain is more than the net short-term capital loss, if any. If capital losses exceed capital gains, the excess can be deducted. The deduction can to reduce other income, such as wages, up to an annual limit of $3,000, or $1,500 for those married filing separately. If the total net capital loss is more than the yearly limit on capital loss deductions, the unused part can be carried over to the next year. 

How It Affects the Economy

Studies show that 70 percent of capital gains go to people in the top 1 percent of income.

That's because most people have their assets in tax-deferred accounts like 401(k)s and IRAs. 

People who live 100 percent off of their investments, no matter how much income they derive, never have to pay more than 20 percent in taxes. This applies even to hedge fund managers and others on Wall Street who derive 100 percent of their income from their investments. In other words, they pay a lower rate than someone making $40,000 a year. 

This does two things. First, it encourages investment in the stock market, real estate, and other assets. That generates business growth. 

Second, it creates more income inequality. That's because those who derive income from their investments are generally already wealthy. They've had enough disposable income in their life to set aside for investments. In other words, they didn't have to use all their income to pay for food, shelter, and health care.

The new tax act will put more people into the 20 percent long-term capital gains tax bracket. How?  The IRS adjusts the income tax brackets each year to compensate for inflation. But they will rise more slowly than in the past. The Act switched to the chained consumer price index. Over time, that will move more people into higher tax brackets.

Capital Gains Tax Rate History

The long-term capital gains tax rate hasn't always been this low. Here's the recent history (for the maximum tax rate) to give you an idea of how it's actually been a political football: 

YearTax RateEvents
191315%Before 1913, 90% of all revenue came from alcohol and cigarette taxes.
192212.5%Tax cut led to stock market crash
193639%Hike revived depression
194225%Revenue Act of 1942
197928%Cut to offset high interest rates.
198220%Recovery Act of 1981
198728%Tax Reform Act of 1986 reduced the income tax to 28% from 50%
199821.19%Clinton lowered it to expand the EITC
201318.3%Obamacare taxes 

Sources for Table: Citizens for Tax Justice, 2013. EconLib.