How does capital gains tax work?

A capital gain is the profit from selling an asset for more than your basis, which is generally what you paid plus certain adjustments. The tax is triggered by the sale, not by the appreciation, so an investment that has tripled generates no tax liability until you sell it. That single feature is why buy-and-hold investing is tax-advantaged relative to frequent trading, entirely apart from any argument about returns.

The holding period determines the rate and the gap is large. Assets held one year or less produce short-term gains taxed at your ordinary income rate, the same as wages. Assets held longer than one year produce long-term gains taxed at preferential rates that are meaningfully lower, with a bracket structure that includes a zero percent rate for filers below an income threshold. That threshold is high enough that some retirees and lower-income households can realize gains at no federal tax at all, which is a genuine planning opportunity that goes unused. High earners may additionally owe the net investment income tax on top.

Several mechanics are worth knowing before you sell anything. Capital losses offset capital gains dollar for dollar, and up to a limited amount of net loss can offset ordinary income each year, with the remainder carrying forward indefinitely. The wash sale rule disallows a loss if you buy a substantially identical security within thirty days before or after the sale. Inherited assets generally receive a stepped-up basis to the value at the date of death, which can erase decades of unrealized gain, making the sequence of what you sell and what you hold a real estate-planning consideration. And your primary residence has its own exclusion of a substantial amount of gain if you owned and lived in it for two of the past five years.