State Capital Gains Tax: An Overview

Capital gains tax is a levy imposed on the profit realized from the sale of a non-inventory asset, such as stocks, bonds, or real estate. While the federal government enforces this tax, individual states have the authority to determine their own capital gains tax policies. As of 2025, 41 states and the District of Columbia impose some form of capital gains tax, with rates and structures varying significantly across the nation.

This variability means that an individual's tax liability on capital gains can differ substantially depending on their state of residence. Understanding these state-specific differences is crucial for investors and residents, as they can influence financial planning, investment strategies, and decisions regarding relocation.

Federal Capital Gains Tax Information

It’s crucial to remember that investors are subject to both federal and state capital gains taxes. For clarity, let’s go over the federal rates for 2025 and discuss what kinds of assets and sales can be taxed for capital gains.

2025 Federal Capital Gains Tax Rates

At the federal level, capital gains taxes are categorized based on the holding period of the asset:

Short-Term Capital Gains: Gains from assets held for one year or less are taxed as ordinary income, with rates ranging from 10% to 37% in 2025, depending on the taxpayer's income bracket.
Long-Term Capital Gains: Gains from assets held for more than one year are taxed at preferential rates: 0%, 15%, or 20%, based on income thresholds. In 2025, single filers with taxable income up to $48,350 pay 0% on long-term capital gains, while those with income over $533,400 pay 20%.

For long-term capital gains, the following rates apply:

Filing Status

Single

0% Rate: Up to $48,350
15% Rate: $48,351 to $533,400
20% Rate: Over $533,400

Married Filing Jointly

0% Rate: Up to $96,700
15% Rate: $96,701 to $600,050
20% Rate: Over $600,050

Head of Household

0% Rate: Up to $64,750
15% Rate: $64,751 to $566,700
20% Rate: Over $566,700

Additionally, high-income earners may be subject to a 3.8% Net Investment Income Tax (NIIT) on capital gains.

Examples of Capital Gains

Capital gains arise when you sell an asset for more than its original purchase price. Below are common examples that illustrate how capital gains can be realized.

1. Stock Sales

If you buy shares of a company for $5,000 and later sell them for $8,000, you realize a capital gain of $3,000. Notably, if you held the stock for more than a year, it’s a long-term gain and may qualify for preferential tax treatment.

2. Real Estate Transactions

Selling a rental property, investment property, or a second home can trigger capital gains. For example, if you purchased a vacation home for $200,000 and sell it years later for $300,000, your gain is $100,000. However, primary residences may qualify for a capital gains exclusion of up to $250,000 (or $500,000 for married couples) under federal law.

3. Cryptocurrency

Selling cryptocurrency for more than you paid triggers a capital gain. For instance, buying Bitcoin at $10,000 and selling it at $15,000 results in a $5,000 gain. The IRS treats crypto as property, so capital gains rules apply.

4. Collectibles

Artwork, rare coins, and vintage cars are also subject to capital gains tax. Gains on collectibles held for over a year may be taxed at a higher maximum rate of 28% federally.

5. Business Asset Sales

If a business owner sells equipment or intellectual property at a profit, the gain is considered capital in nature. This often applies during mergers, acquisitions, or business liquidations.

Capital Gains Taxes on the State Level

While federal capital gains tax rules apply uniformly across the country, state-level taxation varies significantly. Each state determines whether and how it taxes capital gains, leading to a wide range of outcomes for investors and residents. These differences can meaningfully impact an individual’s total tax liability, especially for those with substantial investment income. Below, we explore how different states approach capital gains taxation.

States with No Capital Gains Tax

Several states do not impose any income tax and therefore do not tax capital gains. These include:

Alaska
Florida
Nevada
South Dakota
Tennessee
Texas
Washington
Wyoming

In these states, residents only pay the federal capital gains tax, which can result in a much lower overall tax burden compared to residents in high-tax states. Notably, although Washington State enacted a 7% capital gains tax in 2022, it applies only to certain long-term capital gains over $250,000 and is not considered a traditional income tax by the state. This distinction has been the subject of legal and political debate.

States with Low Capital Gains Tax

Some states do tax capital gains but offer relatively low rates or tax them more favorably than ordinary income.

Arizona: Taxes capital gains as income but has been gradually lowering income tax rates overall.
North Dakota: Offers a deduction for qualified capital gains and has low overall income tax rates.
Pennsylvania: Applies a flat income tax rate of 3.07% to all income, including capital gains.
Indiana: Uses a flat income tax (approximately 3.15% in 2025), which applies to capital gains.

For investors, living in a low-tax state can significantly reduce the tax drag on their investment returns, particularly when compared to states that treat capital gains as high-rate ordinary income.

States with Higher Capital Gains Tax

Some states tax capital gains as regular income and have high income tax rates, resulting in a significant state-level tax burden.

California: Taxes capital gains at ordinary income rates, with a top marginal rate of 13.3%, the highest in the country.
New York: Also taxes capital gains as income, with top rates exceeding 10% when local New York City taxes are included.
Minnesota: Capital gains are taxed as income, with a new high-income surcharge pushing top rates above 10% for some earners.
New Jersey: Applies a top income tax rate of 10.75% to capital gains, depending on the taxpayer’s income bracket.

For high-net-worth individuals, these rates can mean combined federal and state capital gains taxes exceed 50%, creating a strong incentive for tax planning or even relocation.

States with Notable Deductions for Capital Gains

Several states offer deductions, exclusions, or preferential treatment for capital gains, often to encourage investment or target specific asset types.

South Carolina: Allows a deduction of 44% on net long-term capital gains, effectively reducing the tax rate.
Wisconsin: Offers a 30% exclusion for long-term capital gains on assets held for more than one year.
Montana: Provides a 30% net long-term capital gain deduction, though there has been legislative debate around reducing or eliminating it.
Arkansas: Excludes 50% of net capital gains from taxation and exempts all gains over $10 million.

These state-specific policies can create significant savings for long-term investors, especially those who structure their portfolios to take advantage of these incentives.

Deferring Capital Gains Taxes: 1031 Exchanges

One of the most effective strategies for deferring capital gains taxes on real estate investments is the Section 1031 exchange, named after Section 1031 of the Internal Revenue Code. Commonly referred to as a "like-kind exchange," this provision allows investors to defer paying capital gains taxes when they sell an investment property—so long as they reinvest the proceeds into a similar property of equal or greater value.

How a 1031 Exchange Works

In a typical 1031 exchange, an investor sells a qualifying property and uses the proceeds to acquire another property that is also held for business or investment purposes. As long as the exchange is executed according to IRS rules, any capital gains taxes that would normally be due upon the sale of the original property are deferred.

To qualify for a 1031 exchange, several key requirements must be met.

Like-Kind Property: Both the sold and acquired properties must be of “like kind,” which in real estate typically means any type of real property held for investment or business use (e.g., swapping a rental house for a commercial building).
Strict Timelines: The replacement property must be identified within 45 days of selling the original property, and the purchase must be completed within 180 days.
Use of a Qualified Intermediary (QI): The proceeds from the sale must be held and transferred by a QI to avoid constructive receipt by the investor.

Benefits of a 1031 Exchange

Tax Deferral: The primary benefit of a 1031 exchange is the ability to defer capital gains taxes, potentially indefinitely, which can free up more capital for reinvestment.
Portfolio Growth: Investors can leverage gains to acquire larger or more diversified properties without reducing capital through taxes.
Estate Planning: When a 1031-exchanged property is passed to heirs, its value receives a step-up in basis, eliminating the deferred gains and reducing tax liability.

State-Level Considerations for 1031 Exchanges

While 1031 exchanges are recognized under federal law, not all states conform fully to these rules. Some states, such as California and Massachusetts, may require taxpayers to track deferred gains for state tax purposes if the replacement property is located out of state. Others, like New York, follow federal rules but have additional reporting requirements.

For help getting started with a 1031 exchange to defer federal and state capital gains taxes, open an order with First American Exchange Company today.