Capital Gain Income and its Effect on Income Tax Brackets

I have often been asked this question: what is the capital gains rate?  Well, the answer is "it depends". 

First of all, according to Wikipedia,  the tax rate depends on both the individual's tax bracket and the amount of time the asset (the investment sold) was held. Short-term capital gains are taxed at the individual's ordinary income tax rate and are defined as investments "held for a year or less" before being sold. Long-term capital gains, are gains attributable to the dispositions of assets "held for more than one year" and are taxed at a lower capital gains rate.

As of 2016, the United States taxes short-term capital gains at the same rate as it taxes ordinary income. Long-term capital gains, on the other hand, are taxed at generally lower rates with some exceptions:

• The tax on collectibles and certain small business stock is capped at 28%.
• The tax on un-recaptured Section 1250 gain — this is the portion of gains on depreciable real estate (ie. structures used for business purposes) that has been or could have been claimed as depreciation — is capped at 25%.
• Most other investments are subject to a preferential rate of 0%, 15%, or 20%, depending on the tax rate that would be assessed on the same amount of ordinary income.

The dollar amounts ("tax brackets") are adjusted each year based on inflation, and are after deductions and exemptions, which means that there is another bracket of income (that is, essentially,  below the 25% bracket for filers) that has a $0 capital gains rate. 

But secondly, the most misunderstood aspect of the capital gains rate structure is the fact that even capital gains on which the above table shows the tax to be 0% may increase an individual's overall tax liability, as it may push any capital gain income into higher tax brackets. 

What?  Come again?  Well, it appears that what happens is that (and take a deep breath) the capital gain does push an individual's total income into the next tax bracket, but the capital gain is always interpreted as the "last" income the person received, so that if that individual's non-capital-gains income is less than the threshold, it will all be taxed in the lower bracket, and only that individual's capital gain will be taxed in the higher bracket (but it will be taxed at the capital-gains rate of that higher bracket).

In short, a capital gain can only push capital gains into higher capital-gains tax brackets; it cannot push ordinary income into higher ordinary-income tax brackets. In addition, the amount of the capital gain is taxed in a marginal rate fashion, such that any portion of the gain that will "fit" into a lower bracket will be taxed at a lower level, with only the topmost portion of any gain being taxed at the top rate.