Sorry, you need to enable JavaScript to visit this website.
Skip to main content

Wednesday, February 28, 2024

What are short-term capital gains taxes?

What are short-term capital gains taxes?

Capital gains are considered income, which means they are taxed by the IRS. But the IRS doesn't treat all income the same, and some earnings are taxed at higher rates than others.

Find out more about what short-term capital gains are and how they're treated differently from long-term capital gains below.

Understanding short-term gains

Short-term gains tend to be those that are realized within a single year. This means you owned an asset for a year or less before selling it for a profit. Here's an example:

  • You purchase stock on January 15, 2022. 
  • You sell the stock for a profit on November 15, 2022.
  • You owned the stock for less than a year. This profit would be counted as a short-term gain.

This is in contrast to long-term gains. Long-term gains tend to be those related to assets you have owned for more than a year. For example, if you buy stock on January 15, 2022, and don't sell it until February 1, 2023, you owned it for more than a year. Any profit gained during the transaction would likely be considered long-term gains. 

What are short-term capital gains?

Capital gains refer specifically to profits you make when selling an asset. Assets can include stocks, bonds and other property you might own, though there are exceptions. Short-term capital gains are profits you make when you sell an asset you've owned for a year or less.

Short-term capital gain calculation

If you've sold assets you have owned for a year or less, you will owe income tax against the amount of gain.

Many people don't realize that this type of income can bump them into higher tax brackets, which can lead to an unpleasant surprise come tax time. Consider using our capital gains tax calculator to estimate how much you'll owe so you can understand how short-term gains might impact your tax refund or bill.

If you'd prefer to do the job manually, the formula for short-term capital gains tax is:

(Disposition basis - Acquisition basis) x Tax rate

Acquisition basis

Acquisition basis refers to how much you paid for an asset, including sales tax. If the asset in question is a stock or bond, the acquisition basis also includes costs such as transfer fees and commissions. 

Disposition basis

The disposition basis is how much you received, in total, when selling the asset. This is not necessarily how much the buyer pays. For example, if you sell an asset for $1,000 but the transaction includes $50 in fees, you may only walk away with $950. That means your disposition basis would be $950.

An example of the capital gains formula

Let's look at a simple hypothetical example to understand acquisition basis and disposition basis and how they work with the capital gains formula.

  • You buy 100 shares of stock at $5 each. You also pay fees of $15. Your total purchase cost, or acquisition basis, is $515.
  • Later that year, you sell all 100 shares of stock for $8 each. You pay fees of $25. Your disposition basis is $800 minus the $25 in fees, or $775.
  • Your short-term capital gain is $775 minus $515, or $260.

What is the federal short-term capital gains tax rate?

Here's where it gets a bit complicated. There's not one federal short-term capital gains tax rate you can apply to your earnings. The rate of tax you pay depends on:

  • How much you earned in the taxable period
  • The year in which you realized the earnings
  • Your filing status

This is because short-term capital gains are taxed as regular income, so it's based on your income tax bracket. 

Check out the tables below to understand the federal short-term capital gains tax rate you might pay for 2022 earnings and 2023 earnings.

Also, some states may apply a capital gains tax as well, which you will pay when you file your state tax return.

Federal short-term capital gains tax rates 2022-2023

Short-term capital gains are included with your other regular taxable income to help determine how much you pay in taxes overall. Currently, federal tax rates are 10%, 12%, 22%, 24%, 32%, 25% and 37% for 2022 and 2023. Which rate you pay depends on your filing status and how much you earn.

For example, here is the federal tax bracket breakdown for 2022 for a single filer:

Tax Rate

Taxable Income

10%

0 to $10,275

12%

$10,276 to $41,775

22%

$41,776 to $89,075

24%

$89,076 to $170,050

32%

$170,051 to $215,950

35%

$215,951 to $539,900

37%

$539,901+

Short-term capital gains exceptions

It wouldn't be a federal tax without some complexity, and there are numerous exceptions for capital gains. In some cases, the exception means you don't have to pay a tax at all on the proceeds. In others, it means a different tax rate or a cap on how much you might pay.

Collectibles

Collectibles include things like art, coins or cards for which there is a collector's market. If you sell collectibles that you have only owned a year or less, they are taxed as normal income. However, if you hold those collectibles for longer than a year, they are taxed at a long-term capital gains rate that is no more than 28%.

Small business stock

In some cases, you can exclude amounts related to selling small business stock from your taxable income. This is only true for qualified small business stock1, or QSBS. To qualify, a stock has to meet many conditions, including:

  • Being issued by a U.S. company organized as a C corporation
  • Being issued by a corporation that has less than $50 million in assets at all times
  • Not being issued by a holding company
  • Not be acquired as a gift  

Home sales

The IRS provides an exemption for some value of a home sale2 if you owned it and used it as your primary residence at least 2 years out of the previous 5 years. This means that this exemption doesn't apply to short-term capital gains but does apply to long-term capital gains.

If you meet the requirements, you can exempt up to $250,000 in profits from a home sale if you're filing single. If you're married filing jointly, you can exempt up to $500,00 in profits from a home sale.

However, if you sell more than one home within a 2-year period, you may not be able to take this exclusion. 

Real estate investments

If you're investing in real estate, the capital gains tax issue can get even more complex. First, the IRS doesn't really offer any exemptions for those who buy homes and flip them within a few months. This income would be taxed according to regular tax brackets.

One thing you can do to help reduce your personal income tax burden if you are investing in homes to flip them is to do so under the umbrella of a business. You should also keep track of all your expenses because capital gains on these earnings are taxed only on profit. If you buy a home for $100,000, spend $50,000 to fix it up and sell it for $200,000, the taxable profit is only $50,000.

If you are investing in rental properties, the income you make on those properties is typically treated as long-term capital gains and may be taxed at 15% or 20%. However, you can also help protect yourself against taxes and other issues in this case by creating a business structure and buying and renting property as a business instead of as an individual.

How to avoid short-term capital gains tax

A good way to avoid short-term capital gains tax is to stretch your ownership out to more than a year. If you can hold an asset for longer than a year, the profits when you sell it aren't taxed as short-term capital gains.

When you're looking to invest for retirement, consider tax-deferred accounts such as Traditional 401k plans or IRAs. The money in these accounts is invested, and you may buy and sell assets to help  increase your account value. However, the accrual of assets in these accounts is not taxed until you withdraw the assets, and even then, they are not taxed as capital gains. 

You can also sell assets in mixtures to offset capital gains exposure. For example, if you have one asset that would turn a profit of $2,000 and one that would generate a loss of $1,000, you might sell them in the same year. Your total profit in this case would only be $1,000, helping to reduce how much you would owe in capital gains taxes.

Our take

Taxes, in general, can be complex. When you throw investments into the mix, you will want to consider how short-term capital gains might impact your tax bill. Planning helps you consider all the details related to your money and how to plan ahead for taxes, so you're not surprised by what you owe come April.

Solid planning:

  • Helps your money work hard for you and your wealth grow
  • Gives you a clear look at your finances so you can make wise choices
  • Lets you proactively manage expenses such as tax burdens to reduce their cost and the impact they can have on your life

 

1 U.S. Small Business Administration, “Qualified Small Business Stock: What Is It and How to Use It,” April 2017.

2 IRS, “Topic No. 701 Sale of Your Home,” October 2022.

RO2724029-0223

Ian Wymore

Contributor

Ian Wymore is a Senior Financial Advisor at Empower and is committed to helping clients achieve their best financial outcomes. Ian has several years of experience working with high-net-worth individuals and families. Prior to Empower, Ian worked at Morgan Stanley Wealth Management.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. No part of this blog, nor the links contained therein is a solicitation or offer to sell securities. Compensation for freelance contributions not to exceed $1,250. Third-party data is obtained from sources believed to be reliable; however, Empower cannot guarantee the accuracy, timeliness, completeness or fitness of this data for any particular purpose. Third-party links are provided solely as a convenience and do not imply an affiliation, endorsement or approval by Empower of the contents on such third-party websites. 

Certain sections of this blog may contain forward-looking statements that are based on our reasonable expectations, estimates, projections and assumptions. Past performance is not a guarantee of future return, nor is it indicative of future performance. Investing involves risk. The value of your investment will fluctuate and you may lose money. 

Certified Financial Planner Board of Standards Inc. (CFP Board) owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design), and CFP® (with flame design) in the U.S., which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements. 

Advisory services are provided for a fee by Empower Advisory Group, LLC (“EAG”). EAG is a registered investment adviser with the Securities and Exchange Commission (“SEC”) and subsidiary of Empower Annuity Insurance Company of America. Registration does not imply a certain level of skill or training.