Capital Gains Tax: A Beginner's Guide to Short-Term vs. Long-Term Rates

When I first started buying and selling stocks, I never held any shares for longer than a few months. Then tax season rolled around, and I found myself staring blankly at a Schedule D tax form, thinking, “What the heck are capital gains, and why did my tax liability jump?”

If you’re new to investing, there are two ways to make money through stocks: capital gains and dividends. In this post, we’ll break down what capital gains are, how they’re taxed, and why your holding period can make a big difference. But first, a quick refresher on what you actually own when you buy a stock.

WHAT ARE STOCKS?

Many people view stocks as simply something of value to trade for money, like baseball cards or other collectibles. But unlike collectibles, a stock’s value isn’t based on popularity alone. It represents ownership in a real, functioning business.

When you own stocks (aka shares) of Costco, for example, you’re literally a part-owner of Costco. (Full disclosure: I own shares of Costco—sadly, it doesn't come with a lifetime supply of samples.) The percentage you own depends on how many shares you have relative to all the shares in existence. If you somehow owned 10% of Costco’s outstanding shares, you’d own 10% of the company.

In reality, most of us own a microscopic fraction—but that still makes us business owners. And as the business grows, so does the value of our ownership. That’s what gives stocks their worth.

Now that we’ve covered what a stock actually represents, let’s talk about what happens when you sell one.

WHAT ARE CAPITAL GAINS AND LOSSES?

A stock’s price changes constantly, based on everything from company performance to investor mood swings. When you sell, one of two things happens: you either make a capital gain (yay) or take a capital loss (boo). It all depends on what you sell the stock for versus your cost basis, i.e., what you paid for it.

Capital gain: you sell for more than you paid.

Example: you buy one share of Costco for $800 and later sell it for $900. You’ve made a $100 capital gain.

Capital loss: you sell for less than you paid.

Example: you buy for $800 and sell for $600. That’s a $200 capital loss.

While losses aren’t fun, they can actually help you out come tax time—but more on that in a bit.

REALIZED VS. UNREALIZED CAPITAL GAINS

Here’s where things get interesting (and slightly more tax-y).

You only owe taxes on capital gains once they’re realized—meaning you’ve actually sold the stock and pocketed the profit. Until then, it’s just a paper gain (or, as your brokerage calls it, unrealized).

If your portfolio shows that your shares are worth more than you paid, congratulations! You’ve got an unrealized gain. But since you haven’t sold, you don’t owe the IRS a dime (yet).

Sell those shares, though, and it becomes a realized gain—and the taxman cometh. (Sorry. I couldn’t help myself from using the word cometh.)

THE SILVER LINING OF CAPITAL LOSSES

If you do take a loss, there’s one upside: you can use capital losses to offset your gains and reduce your tax bill.

Let’s say you made $5,000 in gains across several stocks but lost $3,000 on others. You’d only pay taxes on the $2,000 difference. It’s like a small consolation prize from the IRS for your investing misfires.

Using capital losses to reduce your net capital gains is one way to reduce your taxes. But there is another way to reduce the taxes you owe on any capital gains.

SHORT-TERM VS. LONG-TERM CAPITAL GAINS TAX

Now we’re getting to the part that can really affect how much tax you pay: how long you hold the stock before selling.

• Short-term capital gains: from stocks you held for one year or less.

  These are taxed just like your regular income—at your ordinary tax rate.

  
  

• Long-term capital gains: from stocks you held for more than one year.

  These get their own much lower tax rates.

Let’s put that into perspective.

If you make $60,000 from your job and $10,000 in short-term capital gains, your total taxable income is $70,000. In 2025, that would put you in the 22% federal tax bracket. Meaning your $10,000 gain would cost you $2,200 in taxes. Ouch.

Now here’s the fun part: long-term capital gains have their own set of tax brackets—and they’re much more favorable.

Yes, it’s possible to owe zero federal taxes on capital gains if your taxable income is low enough and you hold your stocks for over a year.

If, for example, you live solely off investments and realize $45,000 in long-term gains, that income could be completely tax-free. You keep all of it. What’s not to love about zero taxes?

I had no idea about that 0% bracket when I first started investing. Had I known, I probably would’ve held onto my stocks a little longer instead of giving the IRS an unnecessary tip that first year. (Side note: You can also avoid capital gains tax if you invest using a Roth IRA.)

Now, if you’re like me, you might be wondering how long-term capital gains tax rates work if you also have ordinary income, such as from a job. And how do itemized or standard deductions fit into this?

I promise to cover this in a future post. For now, just know that you, as an investor, are rewarded for holding onto stocks for longer than a year.

HOW LONG TO HOLD STOCKS FOR LONG-TERM CAPITAL GAINS

The IRS says a stock is considered long-term if you’ve held it for more than one year before selling.

So, is that 365 days? 366 in a leap year? Not exactly.

The IRS doesn’t give a specific number of days. The rule is: start counting from the day after you bought the stock, and include the day you sell it.

Example:

• Buy on June 15, 2023 → holding period starts June 16, 2023

• Sell on June 15, 2024 → not quite a full year

• Sell on June 17, 2024 → congratulations, you’ve crossed into long-term territory

  
  

The key takeaway: focus on the dates, not the number of days. And maybe don’t try to cut it too close—selling even one day early could mean a much bigger tax bill.

RECAP

• Stocks represent ownership in a company.

• Capital gains (profits) only become taxable once you sell the stock.

• Short-term gains (held ≤ 1 year) are taxed as ordinary income.

• Long-term gains (held > 1 year) get lower tax rates—(0%, 15%, or 20%).

• Capital losses can offset your gains and reduce taxes owed.

If capital gains are about making money through growth, then dividends are about making money through income. In my next post, we’ll unpack dividends, the key dates every investor should know, and whether you could actually live off them.

If this helped clarify the murky world of capital gains, drop a comment below.

See you at the finish line!

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Disclaimer: I’m not a licensed financial professional. This blog shares my personal experiences and opinions around money, investing, and early retirement. It’s for informational and educational purposes only—not financial, legal, or tax advice. Always do your own research or consult with a qualified professional before making any financial decisions.