Short-term capital gains tax: The difference a day can make

This article was fact-checked by our editors and a member of the Credit Karma product specialist team, led by Senior Manager of Operations Christina Taylor. It has been updated for the 2020 tax year.

Different kinds of income can be taxed at different rates. The rate you pay on your salary or self-employment income may differ from the rate you pay on the profit you receive from selling stock or other investments, also known as capital gains.

Capital gains are generally taxed at a lower rate than ordinary income — but not all capital gains are treated equally. The federal tax rate can vary widely between short-term and long-term gains.

• What is a capital gain?
• What is a short-term capital gain?
• Things to know about short-term capital gains taxes

What is a capital gain?

The IRS considers almost everything you own — including real estate, investments and personal property — to be capital assets. Every asset you own has a “basis,” which is essentially what you paid for the assets, including the cost of purchasing it and any taxes or fees associated with the purchase. For example, if you bought collectible artwork for $10,000 and paid a 15% finder’s fee to a collectibles broker, your basis would be $11,500 — the $10,000 purchase price plus the $1,500 finder’s fee.

Your basis may increase if you put money into improving your asset (for example, building an addition on a house that is your primary residence) or decrease if you take depreciation on the asset.

If you sell a capital asset for more than your basis, you have a capital gain that may be subject to federal income tax. But if you sell the asset for less than your basis, you have a capital loss, which may be deductible up to a certain amount.

What is a short-term capital gain?

Capital gains are classified as either long-term or short-term, depending on how long you owned the asset before selling it. In most cases, if you owned the asset for more than one year, it’s a long-term capital gain or loss. If you held it for one year or less, it’s a short-term capital gain or loss.

Long-term capital gains are generally taxed at a lower rate than ordinary income — 0%, 15% or 20%, depending on your tax bracket.

But short-term capital gains don’t benefit from a special tax rate — they’re taxed at the same rate as ordinary income. Here are the 2020 federal tax brackets for regular income.

The difference between a long-term capital gain and a short-term capital gain can come down to just one day. But that one day could mean a difference of hundreds or even thousands of dollars in your tax bill, depending on the total gain and your tax bracket. That’s why it’s crucial to know when the clock starts ticking — it usually starts the day after you acquire the asset and ends up to and including the day you sell it.

Let’s say you paid $10,000 for 100 shares of stock on Jan. 2, 2020. If you sold those shares for $20,000 before Jan. 3, 2021, you’d likely face short-term capital gains tax on the profit. Assuming your taxable income for the year was $100,000 and your marginal tax rate was 24%, your short-term capital gains tax on the transaction would be $2,400.

But if you sold those 100 shares (with the same profit) on or after Jan. 3, 2021, your profit would be considered a long-term capital gain and subject to the lower end of those tax rates. In fact, for this example your gain would likely be taxed at 15%, and you’d pay just $1,500 in tax on your gains. In this case, waiting that extra day would save you $900 in taxes.

Things to know about short-term capital gains taxes

If you’re interested in lowering the amount of tax you might pay on a capital gain, there are a few more things to understand about net capital gains.

A capital loss may be deductible

If you have a capital loss — meaning you sold the asset for less than your basis — it may be deductible. Generally, if you have a capital loss that exceeds your capital gains for the year, you can deduct up to $3,000 ($1,500 if you’re married filing separately). And if your capital loss exceeds that limit, you may be able to carry the amount over and deduct it on next year’s tax return.

But you can’t take a loss deduction for property you held for personal use, such as your primary residence.

You’re taxed on your net capital gain

Instead of applying on an item-by-item basis, the capital gains tax rate applies to your overall net capital gains. The example above assumes you only had one transaction for the tax year. But let’s say you sold four stocks during the year.

• Stock A: Long-term capital loss of $2,000
• Stock B: Long-term capital gain of $5,000
• Stock C: Short-term capital loss of $3,000
• Stock D: Short-term capital gain of $1,000

To calculate your tax, you’d first calculate your net long-term capital gain or loss and your net short-term capital gain or loss.

• Net long-term capital gain: $5,000 – $2,000 = $3,000
• Net short-term capital loss: $1,000 – $3,000 = -$2,000

Then, you’d reduce your net long-term gain by your short-term loss. The result is a net capital gain of $1,000. That $1,000 gain would be taxed at long-term capital gain rates.

On the other hand, consider what would happen if you had both a net long-term gain of $3,000 and a net short-term gain of $2,000. In that case, the long-term capital gains tax rate would apply to the long-term gain and the short-term capital gains tax rate would apply to the short-term gain.

High-income earners might pay more

If your modified adjusted gross income exceeds certain maximums, you’ll have to pay an additional 3.8% net investment income tax, or NIIT, on your capital gains.

Modified adjusted gross income is your adjusted gross income shown on your Form 1040, but with a few adjustments. Those adjustments include adding certain types of nontaxable income, such as untaxed foreign income, nontaxable Social Security benefits and tax-exempt interest. It also includes adding back a few adjustments to income, including deductible IRA contributions and student loan interest.

NIIT applies if your MAGI is above …

• $200,000 for single and head of household filers
• $250,000 for married couples filing jointly and qualifying widow(er)s with a dependent child
• $125,000 for married couples filing separately

Bottom line

Holding on to your investments for longer than a year can be a big advantage when it comes to paying taxes on your capital gains. Whether you sell your property after a few months or a few years, at a loss or a gain, it’s important to keep records of what you bought and sold, when the transaction took place, and how much you paid or received for it. That way, you’ll have the information you need to calculate and report your capital gains and losses.

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She codeveloped an online DIY tax-preparation product, serving as chief operating officer for seven years. She is an Enrolled Agent and the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s degree in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.