Capital Gains Tax: How Timing Can Save You Thousands

Capital gains tax is the tax on profit from selling an investment. The rate you pay depends primarily on one variable: how long you held the asset. Hold for under 12 months and your profit is taxed at ordinary income rates — as high as 37%. Hold for 12 months or longer and you qualify for preferential long-term rates — as low as 0% for most middle-income earners.

Long-Term vs Short-Term Rates

For a taxpayer in the 22% federal income bracket, the difference between selling a stock after 11 months versus 13 months is a 22% rate versus a 15% rate on the same profit. Two months of additional holding time saves 7 cents per dollar of gain — with zero additional risk if you intended to hold the investment anyway. Never sell a significantly appreciated position before the 12-month mark without calculating the tax cost of the timing.

Tax-Loss Harvesting

When investments decline in value, you can sell them to realise the loss and use it to offset capital gains elsewhere in your portfolio. This is tax-loss harvesting. If your harvested losses exceed your gains, up to $3,000 of excess losses can offset ordinary income each year, with the remainder carried forward indefinitely.

One restriction: the wash sale rule prohibits repurchasing the same or "substantially identical" security within 30 days before or after the sale. You can immediately buy a similar but not identical ETF — for example, sell Vanguard's VTI and immediately buy Schwab's SCHB — to maintain your market exposure while locking in the tax loss.

Five Strategies to Reduce Capital Gains

1. Always hold for 12+ months before selling appreciating investments — the rate reduction is substantial and certain
2. Harvest losses annually — review your taxable portfolio each November and December for underwater positions
3. Time large sales in low-income years — if you take a sabbatical, change careers, or retire early, you may qualify for the 0% rate
4. Donate appreciated stock to charity — avoid capital gains entirely while deducting the full fair market value
5. Hold buy-and-hold index funds in taxable accounts — index funds generate minimal taxable events; hold high-turnover strategies inside tax-advantaged accounts

Net Investment Income Tax

Higher-income earners face an additional 3.8% Net Investment Income Tax (NIIT) on investment income including capital gains — applied above $200,000 MAGI (single) or $250,000 (married). This brings the effective federal long-term capital gains rate to 23.8% at the top, plus applicable state taxes. New York and California add 8–13% on top.

Stepped-Up Basis at Death

When an asset is inherited, its cost basis "steps up" to the fair market value at the date of death — eliminating all embedded capital gains. Stock purchased at $10 and worth $80 at death creates no capital gains tax for the heir, whose basis becomes $80. For highly appreciated long-term assets you don't need to sell, holding until death is a legitimate estate planning strategy.