When you sell an investment for more than you paid, the profit is generally a capital gain and must be reported on your federal tax return. Whether that gain is taxed as ordinary income or at a preferential rate depends on how long you held the asset before selling. The IRS sets the specific rates and income thresholds each year in its annual revenue procedures and Publication 550.
What counts as a capital gain
A capital gain arises when you sell a capital asset — stocks, bonds, mutual fund shares, real estate, cryptocurrency, or other investment property — for more than your cost basis. If you sell for less than your basis, you have a capital loss, which can offset gains and, within limits, other income.
Cost basis is generally what you paid for the asset, including commissions or transaction fees. For inherited assets, basis is typically reset to the fair market value at the date of death (the "stepped-up basis" rule). For gifted assets, special rules apply. Keeping accurate purchase records matters because basis determines the size of your gain or loss when you sell.
Short-term vs long-term: why the holding period matters
The holding period — how long you owned the asset before selling — determines which rate category applies.
- Short-term gains result from selling an asset held for one year or less. These are taxed as ordinary income, meaning they are added to your other income and taxed at whatever marginal rate applies to you.
- Long-term gains result from selling an asset held for more than one year. The IRS taxes these at preferential rates, which are generally lower than ordinary income rates for most taxpayers.
The day you acquire an asset starts the holding period clock; the day you sell is the day it stops.
When gains become taxable
A capital gain is only recognized — and only taxable — when a sale or taxable exchange actually occurs. Holding an investment that has grown in value does not trigger a tax liability. This concept is often called "unrealized" versus "realized" gain.
Some situations that do trigger recognition include:
- Selling shares in a brokerage account
- Exchanging one cryptocurrency for another
- Receiving proceeds from a mutual fund's internal sale of securities (reported on Form 1099-DIV)
- Selling a rental property or other investment real estate
Certain transactions, such as like-kind exchanges under Section 1031 for qualifying real property, may allow deferral of gain recognition under specific conditions.
Net investment income tax
Higher-income taxpayers may also owe the Net Investment Income Tax (NIIT), a separate levy on certain investment income including capital gains, above income thresholds the IRS adjusts periodically. The NIIT applies in addition to the standard long-term or short-term rate.
Offsetting gains with losses
Capital losses can reduce your taxable gains dollar-for-dollar. If total losses exceed total gains in a year, you may be able to deduct a limited amount against ordinary income, with the remainder carried forward to future years. The IRS specifies the annual deduction limit and carry-forward rules in Publication 550.
Wash-sale rule: if you sell a security at a loss and buy the same or a substantially identical security within 30 days before or after the sale, the IRS disallows the loss for that year. The disallowed loss is added to the basis of the replacement shares instead.
Reporting capital gains
Gains and losses are reported on Schedule D of Form 1040, with the detail broken out on Form 8949. Brokers report sale proceeds and, for most transactions, cost basis on Form 1099-B, which you receive each January for the prior year. Reconcile your own records against the 1099-B before filing, since broker-reported basis can sometimes be incomplete or incorrect for older holdings.
Where to get help
The rules around cost basis tracking, holding periods, and the interaction of multiple gain categories can become complex, especially for portfolios with dividend reinvestment, stock splits, or inherited assets. A qualified find a tax professional can help you understand how your specific transactions should be reported.
Sources
- IRS Publication 550, Investment Income and Expenses (irs.gov)
- IRS Schedule D instructions (irs.gov)
- IRS Topic No. 409, Capital Gains and Losses (irs.gov)