Capital gains and investment income: how the tax actually works
Investment taxes have a reputation for being complicated. Most of it comes down to two questions: what kind of income is it, and how long did you own it. This guide walks through both in plain English.
The short version. A capital gain is the profit you make when you sell something for more than you paid. If you owned it for more than one year, the profit is taxed at 0, 15, or 20 percent. If you owned it for one year or less, the profit is taxed at your regular income tax rate, which can reach 37 percent.
That one-year line is the single biggest decision in investment taxes, and it is entirely in your control.
What is a capital gain?
A capital gain is your profit on something you sold. You take what you sold it for and subtract what you paid for it. Whatever is left over is the gain.
Say you buy stock for $10,000. Three years later you sell it for $15,000. Your capital gain is $5,000. You are taxed on that $5,000 profit, not on the $15,000 you received.
The amount you originally paid has a name: your cost basis. Anything that adds to what you put into the asset can raise your basis, which lowers your gain. On a rental property, for example, a new roof adds to your basis. A higher basis means a smaller profit on paper, and a smaller tax bill.
This works in reverse too. If you sell for less than you paid, you have a capital loss. Losses are useful, and we will come back to them.
You are usually not taxed until you sell
If an investment goes up in value but you have not sold it, that is an unrealized gain. Unrealized gains are generally not taxed. Your account can grow for twenty years without generating a tax bill, as long as you leave it alone.
Mutual funds are the common exception. A fund can sell investments inside itself and pass the gains along to you. You can owe tax on those distributions in a year when you personally sold nothing.
Short-term vs long-term: the one-year rule
How long you owned the asset decides which tax rate applies. There are only two categories.
| Short-term | Long-term | |
|---|---|---|
| How long you owned it | One year or less | More than one year |
| Tax rate | Your regular income rate, 10% to 37% | 0%, 15%, or 20% |
| Treated like | Wages | Its own separate category |
One day can matter. Selling at the eleven month mark and selling at the thirteen month mark can produce very different bills on the exact same profit.
The 2026 capital gains tax rates
Long-term gains get their own rate schedule, separate from the one that applies to wages. Here are the 2026 numbers.
| Filing status | 0% rate | 15% rate | 20% rate |
|---|---|---|---|
| Single | Up to $49,450 | $49,451 to $545,500 | Above $545,500 |
| Married filing jointly | Up to $98,900 | $98,901 to $613,700 | Above $613,700 |
| Head of household | Up to $66,200 | $66,201 to $579,600 | Above $579,600 |
| Married filing separately | Up to $49,450 | $49,451 to $306,850 | Above $306,850 |
One detail trips up almost everyone. Those numbers are based on your total taxable income, not just the size of your gain. Your regular income fills the lower brackets first, then the gain stacks on top of it. So a large salary can push your gain into a higher bracket before the gain is even counted.
A single filer has $90,000 of taxable income from her job. She sells stock she held for three years and makes a $30,000 profit.
Her income and her gain are added together: $120,000. That is above the $49,450 line where the 0 percent rate ends, and well below $545,500. So the whole gain falls in the 15 percent band.
$30,000 × 15% = $4,500 in federal tax
Now imagine she sold the same stock at eleven months instead of three years. The $30,000 is now a short-term gain, so it is taxed like extra salary. It stacks on top of her $90,000 and runs through the 22 percent and 24 percent brackets.
Tax on the short-term gain: about $6,886
Extra cost of selling two months early: about $2,386
The extra 3.8% most high earners forget
There is a second tax on investment income called the net investment income tax. It adds 3.8 percent on top of whatever rate you already owe.
It applies once your modified adjusted gross income passes $200,000 for a single filer or $250,000 for a married couple filing jointly.
Here is the part worth knowing: those thresholds were written into law in 2013 and are never adjusted for inflation. Every other tax number rises a little each year. These two do not. So each year, a few more households cross them without their income changing in real terms.
Add it to the top long-term rate and the highest federal rate on a long-term gain becomes 23.8 percent.
Other kinds of investment income
Capital gains are only part of the picture. Investments also generate income while you hold them, and not all of it is taxed the same way.
| Type of income | How it is taxed |
|---|---|
| Qualified dividends | At the lower long-term rates: 0%, 15%, or 20%. Most dividends from US companies qualify if you held the stock long enough. |
| Ordinary dividends | At your regular income rate, like wages. |
| Interest | At your regular income rate. Savings accounts, CDs, and most bonds fall here. |
| Municipal bond interest | Usually free from federal tax, and often free from state tax if the bond was issued in your state. |
| Rental income | At your regular income rate, after subtracting expenses and depreciation. |
Your brokerage reports most of this to you on Form 1099-DIV and Form 1099-B, and sends the same information to the IRS.
If you live in Maryland, there is another layer
Everything above is federal. States handle investment income differently, and Maryland is one of the tougher ones.
Maryland treats capital gains as regular income at the state level. On top of that, a 2 percent surtax now applies to net capital gains once your federal adjusted gross income passes $350,000. That threshold looks at your total income, not the size of the gain, so a single property sale can trigger it in an otherwise normal year.
Then your county adds its own income tax. In Howard County that is another 3.2 percent. Add it all up and a large gain in Maryland can face a meaningfully higher combined rate than the federal number alone suggests.
Two strategies that lower the bill
Investment taxes are one of the few areas where timing is almost entirely in your hands. Here are two of the most reliable approaches.
1. Watch the calendar before you sell
This is the simplest one, and the most commonly missed. Holding an asset for more than one year moves the profit from ordinary rates down to long-term rates. In the example above, waiting two extra months saved about $2,386 on a $30,000 gain.
Before selling anything that has grown in value, check the purchase date. If you are close to the one year mark, waiting may be worth far more than whatever moved you to sell today.
2. Use your losses on purpose
Not every investment goes up. When one is down, selling it turns a paper loss into a usable one. That loss then cancels out gains elsewhere, dollar for dollar. This is called tax-loss harvesting.
If your losses are bigger than your gains, you can use up to $3,000 of the extra against your regular income each year. Anything beyond that carries forward to future years and never expires.
One rule to respect: the wash sale rule. If you buy the same investment, or one that is substantially identical, within 30 days before or after the sale, the loss is disallowed for now. It gets added to the cost of the new position instead. The usual workaround is buying something similar but not identical, which keeps you invested while the loss still counts.
Same investor, same $30,000 long-term gain. She also holds a fund that is down $10,000. She sells it before year-end.
$30,000 gain − $10,000 loss = $20,000 taxed
Tax at 15%: $3,000 instead of $4,500
These two are the starting point, not the list
Timing and loss harvesting work for almost everyone. Once income and complexity rise, several other approaches open up that are harder to apply on your own:
- Giving appreciated stock to charity instead of cash, which can avoid the gain entirely
- Spreading a large sale across multiple years with an installment sale
- Placing which investments sit in which type of account, so the tax-heavy ones are sheltered
- Deferring gain into a qualified opportunity fund
- Using 1031 exchanges on investment real estate
- Managing income around the $350,000 Maryland surtax line and the net investment income thresholds
Which of these apply depends entirely on your situation, and most of them have to be set up before the year closes rather than at filing time. If you are facing a significant gain, it is worth a conversation before you sell.
Talk to a CPA About Your SituationCommon questions
What is a capital gain?
A capital gain is the profit you make when you sell something for more than you paid for it. If you buy stock for $10,000 and sell it for $15,000, your capital gain is $5,000. You are taxed on the $5,000 profit, not on the $15,000 you received.
What are the 2026 capital gains tax rates?
For 2026, long-term capital gains are taxed at 0, 15, or 20 percent depending on your taxable income. Single filers pay 0 percent up to $49,450, 15 percent up to $545,500, and 20 percent above that. Married couples filing jointly use $98,900 and $613,700. Short-term gains are taxed as ordinary income instead.
What is the difference between short-term and long-term capital gains?
The difference is how long you owned the asset. One year or less makes it short-term, taxed at your regular rate of up to 37 percent. More than one year makes it long-term, taxed at 0, 15, or 20 percent.
What is the 3.8% net investment income tax?
It is an extra 3.8 percent tax on investment income for higher earners. It applies when modified adjusted gross income passes $200,000 for single filers or $250,000 for married couples filing jointly. These thresholds are set by statute and are not adjusted for inflation, so more households cross them every year.
How can I reduce capital gains tax?
Two common approaches are holding an asset for more than one year before selling, which moves the profit to the lower long-term rates, and tax-loss harvesting, which uses losses on other investments to offset gains. Both require action before the tax year ends. For more advanced strategies on a significant capital gain, contact us.
Do I pay capital gains tax if I do not sell?
Generally no. A gain you have not sold is an unrealized gain, and unrealized gains are not taxed. Mutual funds are the exception, because a fund can pass capital gain distributions to you even in a year when you sold nothing.
What is the wash sale rule?
It stops you from claiming a loss if you buy the same investment, or one that is substantially identical, within 30 days before or after the sale. The disallowed loss is added to the cost basis of the new position rather than lost permanently.
Sources: IRS Revenue Procedure 2025-32 (2026 rate thresholds); IRS Topic No. 409, Capital Gains and Losses; Comptroller of Maryland Technical Bulletin 58 (Maryland capital gains surtax). Figures reflect law in effect as of July 2026 and are subject to change.
This article is general education and does not constitute tax, legal, or investment advice. Reading it does not create a client relationship. The rules described have exceptions and depend on your specific facts. Please speak with a qualified tax professional about your own situation.