The sale of an asset for more than its cost produces a capital gain. The sale for less produces a capital loss. Those facts are familiar. What matters for tax purposes is how those gains and losses are classified, measured, and offset against each other, because the rate applied to a capital gain can range from 0% to 37% depending on how long the asset was held and what type of asset it was.

For investors, founders selling equity, homeowners, and anyone holding property across borders, the mechanics covered in this article are some of the most consequential in the entire individual tax return. A misunderstanding of cost basis, holding period, or the primary residence exclusion can produce a tax bill significantly higher than necessary. This article covers the full structure of US capital gains taxation: the short-term and long-term distinction, how basis is determined and adjusted, the netting rules for gains and losses, the wash sale rule, the primary residence exclusion, Section 1231 gains from business property, and the additional complexity that arises when property is held by non-US persons or involves assets in multiple jurisdictions.

Short-term versus long-term gains

The most important classification in capital gains taxation is the holding period. A capital gain is short-term if the asset was held for one year or less. It is long-term if the asset was held for more than one year. The difference in tax rate between the two categories is substantial and represents one of the strongest incentives in the US tax code to defer a sale.

Short-term capital gains are taxed at ordinary income rates. For a taxpayer in the 37% bracket, that means a short-term gain is taxed the same way wages are taxed. There is no preferential treatment.

Long-term capital gains are taxed at 0%, 15%, or 20%, depending on taxable income. For 2025, the 0% rate applies to taxable income up to $48,350 for single filers and $96,700 for married filing jointly. The 15% rate applies from those thresholds up to $533,400 for single filers and $600,050 for married filing jointly. The 20% rate applies to income above those amounts. These brackets are separate from the ordinary income brackets, and long-term capital gains income is stacked on top of ordinary income when determining which rate applies.

Example

Nina is a single filer with $60,000 of wage income and $40,000 of long-term capital gains. Her taxable income after the standard deduction of $15,750 is approximately $84,250.

Her ordinary income of $44,250 (after the standard deduction) falls in the 22% bracket.

Her long-term gains of $40,000 are stacked on top. The 0% rate applies to long-term gains up to $48,350 of taxable income. She has already used $44,250 of ordinary income, so only $4,100 of gains falls in the 0% band. The remaining $35,900 is taxed at 15%.

Total capital gains tax: $0 on the first $4,100 and $5,385 on the remaining $35,900. Effective rate on her gains: approximately 13.5%.

Had these been short-term gains, they would have been taxed at 22%, producing a tax of $8,800 on the same $40,000.

How the holding period is counted

The holding period begins on the day after the asset is acquired and includes the day of sale. An asset acquired on January 15 and sold on January 15 of the following year has been held for exactly one year, which is not more than one year. To qualify for long-term treatment, it must be held until at least January 16.

For inherited property, the holding period is automatically long-term regardless of how long the heir holds the asset. A beneficiary who inherits stock and sells it the next day recognizes long-term capital gain. This rule applies even if the decedent held the property for only a short time before death.

For gifted property, the recipient generally takes the donor's holding period. If the donor held the asset for three years before gifting it, the recipient is treated as having held it for three years from the moment of receipt.

Cost basis: the starting point for every gain or loss

A capital gain or loss is the difference between the amount realized on sale and the adjusted basis of the asset. Basis is not always the purchase price. It starts as the purchase price, including acquisition costs such as commissions and fees, and is then adjusted upward or downward for various events during the holding period.

Original basis

For purchased property, original basis is cost: the amount paid for the asset plus any directly attributable acquisition costs. For securities, this means the purchase price plus any commission paid. For real property, it includes the purchase price, closing costs such as title insurance and recording fees, and legal fees directly related to the acquisition.

Adjusted basis

Basis is increased by capital improvements and decreased by depreciation deductions taken. For real property used in a business or as a rental, the depreciation claimed each year reduces basis. When the property is eventually sold, the accumulated depreciation reduces the seller's basis, producing a larger gain. Part of that gain is then subject to recapture as ordinary income at a maximum rate of 25%, rather than at the long-term capital gains rate. This is called unrecaptured Section 1250 gain and is covered in the Section 1231 section below.

For securities, stock splits affect basis on a per-share basis but not in aggregate. A two-for-one split doubles the number of shares and halves the per-share basis. Return of capital distributions from a fund or company reduce basis. Once basis reaches zero, any further return of capital is immediately taxable as a capital gain.

Basis for inherited property

Property inherited from a decedent receives a stepped-up basis equal to the fair market value at the date of death. This is one of the most significant provisions in the individual tax code for wealth transfer purposes. If a decedent held appreciated stock worth $500,000 that was purchased for $50,000, the heir's basis is $500,000. The $450,000 of appreciation that accumulated during the decedent's lifetime is never taxed as a capital gain.

The step-up applies to the decedent's gross estate regardless of whether estate tax is owed. For 2025, the estate tax exemption is $13.99 million per individual, so the vast majority of estates pay no estate tax while still benefiting from the stepped-up basis on all assets.

For community property held by a married couple in a community property state, both halves of the community property receive a step-up at the death of either spouse. This is more favorable than the treatment in non-community-property states, where only the decedent's half receives the step-up.

Basis for gifted property

The basis rules for gifts are more complex than for inheritance. When property is gifted, the recipient's basis depends on whether the property has appreciated or depreciated since the donor acquired it.

If the fair market value at the time of the gift exceeds the donor's basis, the recipient takes the donor's carryover basis. Any gain recognized on a subsequent sale is measured from that original cost.

If the fair market value at the time of the gift is less than the donor's basis, two separate basis figures apply. For computing gain, the recipient uses the donor's basis. For computing loss, the recipient uses the fair market value at the date of the gift. If the sale price falls between the two figures, neither gain nor loss is recognized. This rule prevents donors from gifting built-in losses to shift the tax benefit to a different taxpayer.

Example

Clare's mother gifts her shares with a donor basis of $10,000 and a fair market value at gift date of $6,000.

Clare later sells the shares for $7,500.

For gain purposes, her basis is $10,000. Sale price of $7,500 minus $10,000 basis: a loss of $2,500. But for loss purposes, her basis is $6,000. Sale price of $7,500 minus $6,000: a gain of $1,500.

The sale price falls between the two basis figures. Result: no gain and no loss is recognized.

Identifying which shares were sold: specific identification and FIFO

When a taxpayer holds multiple lots of the same security acquired at different times and prices, the method used to identify which shares were sold affects both the gain or loss recognized and the holding period. The IRS generally applies a first-in, first-out rule by default, treating the oldest shares as sold first. However, a taxpayer can use specific identification if they identify the particular shares being sold at the time of the transaction and receive a confirmation from the broker.

Specific identification allows a taxpayer to choose which lot to sell strategically: selling the highest-basis shares minimizes the current gain, while selling shares held for more than a year ensures long-term treatment. Brokers are required to track and report cost basis for most securities, and the elections available vary by account type.

Netting capital gains and losses

Capital gains and losses are netted within categories before they produce a tax result. The netting process follows a specific order that matters when there are both short-term and long-term transactions in the same year.

Short-term gains and losses are netted first to produce either a net short-term gain or a net short-term loss. Long-term gains and losses are netted separately to produce a net long-term gain or loss. If both results are gains, each is taxed in its own category. If both are losses, they are combined and subject to the loss limitation rules. If one is a gain and the other is a loss, they offset each other and only the net result is taxable or deductible.

The annual limit on the deductibility of capital losses against ordinary income is $3,000 ($1,500 for married filing separately). Losses in excess of this amount are carried forward indefinitely and retain their character, meaning short-term losses remain short-term and long-term losses remain long-term in the carryforward year. There is no expiration on capital loss carryforwards, and they survive until used or until the taxpayer dies.

Example

Patrick has the following transactions in 2025: short-term gain of $8,000 on stock A; short-term loss of $5,000 on stock B; long-term gain of $20,000 on stock C; long-term loss of $25,000 on stock D.

Step 1: Net short-term positions. $8,000 gain minus $5,000 loss = $3,000 net short-term gain.

Step 2: Net long-term positions. $20,000 gain minus $25,000 loss = $5,000 net long-term loss.

Step 3: Combine. $3,000 short-term gain offset against $5,000 long-term loss = $2,000 net long-term loss.

Patrick can deduct $2,000 against ordinary income in 2025. There is no carryforward.

The wash sale rule

The wash sale rule prevents a taxpayer from recognizing a loss on the sale of a security and then immediately repurchasing the same or substantially identical security to restore the position. Without this rule, investors could generate tax losses on paper while maintaining their economic exposure to the asset.

A wash sale occurs when a taxpayer sells a security at a loss and, within the period beginning 30 days before the sale and ending 30 days after the sale, buys the same or a substantially identical security. If a wash sale occurs, the loss is disallowed for the current year. However, the disallowed loss is added to the basis of the newly purchased securities, which preserves it for recognition when those securities are eventually sold outside the wash sale window.

The wash sale window is 61 days in total: 30 days before, the sale date itself, and 30 days after. Buying back on day 31 after the sale is permissible and avoids the rule. The replacement security must be acquired in the taxpayer's account, in a spouse's account, or in an IRA. Selling in a taxable account and repurchasing in an IRA triggers the wash sale but the disallowed loss is lost permanently, because the IRA's basis is not tracked in the same way.

EA exam note

The wash sale rule applies to securities. It does not currently apply to cryptocurrency, which is classified as property rather than a security under existing IRS guidance. Crypto investors can therefore sell at a loss and immediately repurchase without triggering the wash sale rule, though proposed legislation to extend the rule to crypto has been discussed repeatedly.

Example

Sandra sells 100 shares of a technology company on November 10 at a loss of $4,000. On November 25, she buys 100 shares of the same company.

The repurchase is within 30 days of the sale. The $4,000 loss is disallowed in the current year.

The $4,000 is added to the basis of the shares purchased on November 25. If she sells those shares in January at the same price she paid in November, she will recognize a $4,000 loss at that point.

The primary residence exclusion

Section 121 of the Internal Revenue Code allows a taxpayer to exclude from gross income up to $250,000 of gain from the sale of a principal residence ($500,000 for a married couple filing jointly). This exclusion is one of the most valuable provisions in individual tax law and applies regardless of the taxpayer's age, unlike the prior rules that restricted it to one-time use after age 55.

Ownership and use tests

To qualify for the full exclusion, the taxpayer must have owned the home and used it as a principal residence for at least two of the five years immediately before the sale. The two years of ownership and the two years of use do not need to be the same two years, and they do not need to be consecutive. A taxpayer who owned the home for three years but rented it out for the first year still satisfies the test if they lived in it for the subsequent two years.

Only one home can be a principal residence at any time. A person with multiple properties must establish which is their principal residence based on facts and circumstances: where they spend the most time, where they are registered to vote, where their vehicles are registered, and where they receive mail are all relevant indicators.

The $500,000 exclusion for married couples

For married couples filing jointly, the exclusion doubles to $500,000. Both spouses must meet the use test, meaning both must have lived in the home as a principal residence for at least two of the five years before the sale. However, only one spouse needs to meet the ownership test. A couple where one spouse has owned the home for three years and both have lived in it qualifies for the full $500,000 exclusion.

Reduced exclusion for partial qualification

A taxpayer who does not meet the two-year tests due to a change in employment, health reasons, or other unforeseen circumstances may still qualify for a partial exclusion. The partial exclusion is calculated as a fraction: the number of months the home was owned and used as a residence divided by 24, multiplied by the full exclusion amount.

Example

David bought a home and lived in it as his principal residence. After 14 months, he received a job offer in another city requiring him to relocate.

He does not meet the two-year use test. However, the relocation qualifies as a change in employment location under the safe harbor rules.

Partial exclusion: 14/24 x $250,000 = $145,833.

If David's gain is $110,000, the full gain is excluded even under the partial exclusion. If his gain were $200,000, he would exclude $145,833 and recognize $54,167 as a taxable long-term capital gain.

Periods of non-qualified use

A portion of the gain is not eligible for the exclusion if the property was used for non-qualified purposes after 2008. Non-qualified use includes periods when the property was used as a rental or for business purposes, but not periods of absence due to health, employment, or military service up to specified limits.

The non-qualified use fraction is calculated as the number of days of non-qualified use after 2008 divided by the total days of ownership. That fraction of the total gain is not eligible for the exclusion. The remaining gain is then compared to the exclusion amount.

This provision is relevant for homeowners who converted a rental property to a primary residence before selling. Rental periods prior to 2009 are excluded from the calculation under grandfathering rules, but rental periods after 2008 reduce the eligible exclusion proportionally.

Rental property: depreciation and passive activity rules

Residential rental property is depreciated over 27.5 years using the straight-line method. Commercial real property uses a 39-year recovery period. The depreciable basis is the cost of the property minus the value of the land, because land does not wear out and is not depreciable. If a property is purchased for $350,000 and the land is assessed at $70,000, the depreciable basis is $280,000. Annual depreciation is $280,000 divided by 27.5, which is approximately $10,182 per year.

The first and last year of ownership use the mid-month convention, which treats the property as placed in service or disposed of at the midpoint of the month in which it actually occurred. A property placed in service in March is treated as placed in service on March 15, producing 9.5 months of depreciation in the first year rather than a full 12.

Depreciation on rental property must be claimed. If a taxpayer fails to claim depreciation they were entitled to, the IRS still applies depreciation recapture on sale as if the deductions had been taken. The proper correction for missed depreciation is a change in accounting method filed on Form 3115, not an amended return.

Rental income and expenses, including depreciation, are reported on Schedule E. Net rental income is passive income. Net rental losses are passive losses, which under the passive activity loss rules can only be deducted against passive income from other sources, not against wages or self-employment income. There is one significant exception: a taxpayer who actively participates in rental activity and whose modified AGI is $100,000 or below can deduct up to $25,000 of rental losses against ordinary income. This allowance phases out between $100,000 and $150,000 of modified AGI and is eliminated entirely above $150,000. Active participation is a lower standard than material participation and requires only that the taxpayer make management decisions such as approving tenants, setting rents, and authorizing repairs.

Unused passive losses are not lost. They are suspended and carried forward to offset passive income in future years, or are released in full in the year the property is sold in a fully taxable transaction.

Section 1231 gains and business property

Not all property sold by an individual is a capital asset. Property used in a trade or business, such as equipment, machinery, buildings, and land held for use in a business, falls under Section 1231. The treatment of Section 1231 gains and losses is asymmetric in a way that generally favors the taxpayer: net Section 1231 gains are treated as long-term capital gains, while net Section 1231 losses are treated as ordinary losses.

This asymmetry makes Section 1231 property attractive: gains receive preferential capital gains rates while losses produce ordinary loss deductions, which are more valuable because they offset income taxed at higher ordinary rates.

Depreciation recapture

The benefit of Section 1231 treatment is partially clawed back through depreciation recapture. When depreciable real property (Section 1250 property) is sold at a gain, the portion of the gain attributable to previously claimed depreciation is taxed at a maximum rate of 25% rather than at the 20% long-term capital gains rate or the 0% or 15% rates available to lower-income taxpayers. This is called unrecaptured Section 1250 gain.

For personal property such as equipment (Section 1245 property), the recapture rules are more aggressive. The full amount of depreciation previously claimed is recaptured as ordinary income, regardless of how long the asset was held. Only the gain above the original cost (if any) is Section 1231 gain eligible for capital gain treatment.

Example

Rita purchased rental property for $300,000 and claimed $54,750 of depreciation over the following years. Her adjusted basis is therefore $245,250. She sells the property for $380,000.

Total gain: $380,000 minus $245,250 = $134,750.

Of this, $54,750 represents unrecaptured Section 1250 gain and is taxed at a maximum rate of 25%.

The remaining $80,000 is Section 1231 gain eligible for the regular long-term capital gains rates of 0%, 15%, or 20% depending on her taxable income.

The Section 1231 lookback rule

If a taxpayer has claimed Section 1231 ordinary loss deductions in any of the five preceding years, any Section 1231 gain in the current year must first be used to recapture those losses as ordinary income before the remainder is treated as capital gain. This prevents a taxpayer from taking ordinary loss deductions in one year and then recognizing capital gain treatment on the subsequent recovery in a later year.

The net investment income tax and capital gains

As discussed in Part 2, the net investment income tax applies a 3.8% surtax to net investment income for taxpayers with modified adjusted gross income above $200,000 for single filers and $250,000 for married filing jointly. Capital gains are included in net investment income, which means that long-term capital gains taxed at 20% carry an effective rate of 23.8% for taxpayers above the threshold.

The NIIT thresholds are not indexed for inflation, meaning they capture an increasing share of taxpayers each year in real terms. For taxpayers near the threshold, the combined effect of crossing into the 20% long-term gains rate and triggering the NIIT produces a significant jump in the effective marginal rate on investment income.

Gains from the sale of a principal residence that exceed the Section 121 exclusion are subject to the NIIT if the taxpayer is above the threshold. The exclusion itself is not investment income, but any excess gain is.

Capital gains for non-US persons: FIRPTA and withholding

Non-resident aliens who sell US real property are subject to tax on the gain under the Foreign Investment in Real Property Tax Act, known as FIRPTA. The buyer is required to withhold 15% of the gross sales price and remit it to the IRS unless an exception applies. This withholding is not a final tax: the seller files a US return and the withheld amount is credited against the actual tax liability.

FIRPTA applies to sales by foreign persons of US real property interests, which includes direct ownership of real estate as well as interests in US real property holding corporations. A corporation is a US real property holding corporation if more than 50% of its assets are US real property interests.

Exceptions to FIRPTA withholding include sales where the buyer acquires the property as a personal residence and the sale price does not exceed $300,000, sales of publicly traded stock, and situations where the IRS issues a withholding certificate reducing or eliminating the withholding obligation based on the seller's expected actual tax liability.

Non-resident aliens are generally not subject to US tax on capital gains from the sale of securities unless they were physically present in the United States for 183 or more days during the tax year. If that threshold is met, gains from US sources are taxed at 30%, subject to any applicable treaty reduction.

Cross-border note for expats and founders

US citizens and resident aliens who sell property located outside the United States recognize the gain or loss on their US return. The gain is measured in US dollars, which means that changes in currency exchange rates between the acquisition date and the sale date affect the dollar-denominated gain even if the property's value in local currency has not changed.

Foreign tax credits may offset the US tax on gains that are also taxed in the country where the property is located, but the foreign tax credit rules impose limitations that prevent a dollar-for-dollar offset in all cases. These interactions are covered in Part 10.

Installment sales

When a taxpayer sells property and receives the payment in installments over more than one year, the gain can be recognized proportionally as payments are received rather than all in the year of sale. This is the installment method and it applies automatically unless the taxpayer elects out.

The gross profit ratio is calculated as the gross profit divided by the contract price. Each payment received is multiplied by this ratio to determine how much gain is recognized in that year. The remaining portion of each payment represents return of basis, which is not taxable.

The installment method is not available for sales of publicly traded securities, for sales of inventory, or for sales where the taxpayer elects out. Electing out may be beneficial when the taxpayer expects to be in a lower tax bracket in future years or when the installment reporting would cause the income to be taxed at higher rates due to the impact on other thresholds.

Depreciation recapture is recognized in full in the year of sale regardless of the installment method. Only the remaining gain uses the installment reporting approach.

Example

Marcus sells business equipment for $200,000, receiving $50,000 at closing and $50,000 per year for three additional years. His adjusted basis in the equipment is $80,000. Previously claimed depreciation was $30,000.

Step 1: Depreciation recapture of $30,000 is recognized as ordinary income in the year of sale.

Remaining gain: $200,000 minus $80,000 = $120,000, minus $30,000 recapture already recognized = $90,000 of Section 1231 gain to be reported on installment.

Gross profit ratio: $90,000 / $200,000 = 45%. Each $50,000 payment produces $22,500 of Section 1231 gain and $27,500 of basis recovery.

Marcus reports $22,500 of Section 1231 gain in each of the four years, plus the $30,000 ordinary recapture income in year one.

Next: Part 5 covers retirement accounts and distributions, including the rules governing traditional IRAs, Roth IRAs, required minimum distributions, early withdrawal penalties, and the tax treatment of distributions from employer plans.

This article is published by Antravia Advisory. It is for informational purposes only and does not constitute tax advice. Individual circumstances vary and you should seek advice from a qualified practitioner before making decisions that affect your tax position.

About Antravia Advisory

Antravia Advisory is a cross-border tax and advisory firm working with individuals whose tax positions are not straightforward. We support founders, investors, expats, and internationally mobile households who need more than basic tax preparation.

We advise on US individual tax, international reporting, and the interaction between multiple tax systems, including situations involving foreign income, overseas assets, and dual-country obligations. This includes expats living in the United States, US persons living abroad, and families managing financial lives across jurisdictions.

Our work goes beyond filing. We focus on structuring, planning, and ensuring that positions are technically correct, defensible, and aligned across years.

Disclaimer:
Content published by Antravia is provided for informational purposes only and reflects research, industry analysis, and our professional perspective. It does not constitute legal, tax, or accounting advice. Regulations vary by jurisdiction, and individual circumstances differ. Readers should seek advice from a qualified professional before making decisions that could affect their business.

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