Long-Term Capital Gains

Profits from selling a capital asset held for more than one year, taxed at preferential federal rates (0%, 15%, or 20%) — significantly lower than ordinary income tax rates for most taxpayers.

Long-term capital gains (LTCG) are profits realized on the sale of a capital asset that was owned for more than one year before the sale. The IRS taxes these gains at preferential rates — currently 0%, 15%, or 20% at the federal level — rather than at ordinary income tax rates, which can reach 37%. This distinction is one of the most valuable tax advantages available to individual investors and equity compensation holders: by simply holding an asset one day longer than a year, the marginal tax rate on any gain can drop by 10–20 percentage points or more.

The long-term capital gains rates are progressive but use a separate rate schedule from ordinary income. For 2024, single filers pay 0% on long-term gains if their taxable income is at or below approximately $47,025; 15% on gains that keep their income between $47,025 and $518,900; and 20% on gains above the $518,900 threshold. Importantly, long-term capital gains income is 'stacked on top of' ordinary income for purposes of determining which rate applies — if you have $100,000 in ordinary income and $50,000 in long-term capital gains, the gains are taxed as if they are the top slice of your income for rate purposes.

For employees with equity compensation, the one-year holding period is a critical planning threshold. RSUs that vest and are immediately sold produce no capital gain at all (basis equals proceeds), but if held and later sold at a higher price, the appreciation beyond the vesting price is taxed as capital gains — long-term if held for over a year after vesting, short-term if not. For stock options, the holding period calculation can be more complex: for ISOs, a qualifying disposition requires both two years from grant and one year from exercise; for NSOs, any appreciation after exercise is long-term if the shares are held more than a year post-exercise. The tax differential between short-term (ordinary rate) and long-term is often large enough to justify delaying a sale, even accounting for market risk.

State taxes substantially affect the net benefit of long-term capital gains treatment. California, for example, taxes all capital gains — short- and long-term — as ordinary income at state rates up to 13.3%. New York taxes capital gains as ordinary income at up to 10.9%. In these high-tax states, the federal benefit of long-term treatment (saving 10–17 percentage points federally) is partially offset by the state-level tax that applies regardless. Residents of states with no income tax (Texas, Washington, Florida, Nevada) capture the full federal benefit. This is one reason why geography matters significantly in equity compensation planning.

The One-Year Holding Period: Practical Implications

  • The holding period starts the day after acquisition (the trade date for purchased shares; the vest date for RSUs; the exercise date for stock options).
  • To qualify for long-term treatment, you must sell on or after the one-year anniversary of acquisition — selling on day 364 is short-term; day 366 is long-term.
  • For RSUs: if you don't sell at vesting, your LTCG clock starts at the vest date. The one-year mark is when subsequent appreciation becomes eligible for preferential rates.
  • For NSOs: the spread at exercise is always ordinary income regardless of holding period. The LTCG clock for post-exercise appreciation starts at the exercise date.
  • For ISOs: the favorable treatment requires holding for both 2 years from grant and 1 year from exercise. Selling before either threshold creates a disqualifying disposition, converting the gain to ordinary income.

The 0% Rate: An Underused Planning Opportunity

The 0% long-term capital gains rate applies to gains for single filers with taxable income up to approximately $47,025 (2024). This is a genuinely valuable planning opportunity in years when your income is lower than usual — a year you take unpaid leave, a gap year, a year of significant deductions, or early retirement before Social Security begins. In these years, you can realize long-term capital gains at zero federal tax cost. This strategy — sometimes called 'gain harvesting' — is the inverse of tax-loss harvesting: instead of realizing losses to offset gains, you deliberately realize gains in low-income years to reset your cost basis at favorable or zero tax cost. Many people miss this opportunity because they focus only on avoiding taxes rather than timing them.

Net Investment Income Tax (NIIT)

High earners face an additional 3.8% Net Investment Income Tax on top of the capital gains rates. The NIIT applies to the lesser of (a) net investment income (including long-term capital gains) or (b) the amount by which your modified adjusted gross income exceeds $200,000 (single) or $250,000 (married filing jointly). This effectively creates a top combined federal rate of 23.8% (20% + 3.8%) on long-term capital gains for high earners — still significantly below the 37% top ordinary income rate, but a meaningful addition. State income taxes layer on top of this.

Example

A software engineer in Texas vests 500 RSUs at $40/share ($20,000, reported as W-2 income). She holds the shares and sells 18 months later at $60/share. The $10,000 gain ($20 × 500) is long-term capital gains. Her total income that year is $220,000, putting her in the 15% LTCG bracket. Federal tax on the gain: $1,500 (15%). State tax: $0 (Texas has no income tax). If she had sold immediately after vesting and reinvested, the entire $20,000 in appreciation would have been taxed as ordinary income at her 32% federal marginal rate — a difference of $3,400 in federal taxes alone on this single tranche.