Preferential tax rates are the reduced federal income tax rates that apply to long-term capital gains and qualified dividends, in place of the higher rates that apply to wages and other ordinary income. For 2026, they top out at 20%, compared with a 37% ceiling on ordinary income. Only two kinds of income qualify, and each carries its own conditions.
What Income Qualifies
Two categories receive preferential treatment: long-term capital gains and qualified dividends. Wages, freelance income, interest, short-term investment profits, and rental income are all taxed at ordinary rates.
Long-Term Capital Gains
A long-term capital gain is the profit from selling a capital asset you held for more than one year.1Office of the Law Revision Counsel. 26 US Code 1222 – Other Terms Relating to Capital Gains and Losses The holding period starts the day after you buy and runs through the day you sell. Sell at exactly the one-year mark or earlier and it’s a short-term gain, with no preferential treatment.
Capital assets include stocks, bonds, real estate held for investment, and personal items like jewelry or vehicles sold above their purchase price. The tax code defines a capital asset broadly, then carves out specific exceptions such as business inventory, depreciable business property, and accounts receivable.2Office of the Law Revision Counsel. 26 USC 1221 – Capital Asset Defined That last exclusion catches people off guard. A real estate dealer who flips properties as a primary business does not hold those properties as capital assets, and the profits do not get preferential rates.
Qualified Dividends
Not every dividend qualifies. The payment must come from a U.S. corporation or from a foreign corporation whose country has a comprehensive tax treaty with the United States (or whose stock trades on a major U.S. exchange).3Legal Information Institute. 26 USC 1(h)(11) – Dividends Taxed as Net Capital Gain
You also have to hold the stock long enough. The rule requires ownership for more than 60 days during the 121-day window that starts 60 days before the ex-dividend date, which is the cutoff after which a buyer no longer receives the upcoming payout.3Legal Information Institute. 26 USC 1(h)(11) – Dividends Taxed as Net Capital Gain Buy shares right before a dividend and sell soon after, and the payment is taxed at ordinary rates.
Short-Term Gains Are Taxed at Ordinary Rates
Sell an asset within a year and the profit is a short-term capital gain, taxed at whatever ordinary income rate applies to your bracket. For 2026, that reaches 37% at the top.4Internal Revenue Service. Topic No. 409, Capital Gains and Losses Holding a winning position for 366 days instead of 364 can nearly halve the rate for someone at the top of the income scale. The one-year-and-a-day threshold matters more than most people realize.
2026 Rate Brackets
Preferential income falls into three tiers: 0%, 15%, and 20%. Which rate applies depends on your total taxable income for the year, not just the amount of investment income. For 2026, the thresholds are:5Internal Revenue Service. Rev Proc 2025-32 – Tax Year 2026 Inflation Adjustments
- 0% rate: taxable income up to $49,450 for single filers, or up to $98,900 for married couples filing jointly.
- 15% rate: taxable income from $49,451 to $545,500 for single filers, or from $98,901 to $613,700 for joint filers.
- 20% rate: taxable income above $545,500 for single filers, or above $613,700 for joint filers.
The 0% bracket is genuinely zero. If taxable income after deductions stays below the threshold, you pay nothing on your long-term gains and qualified dividends.
How the Rate Is Actually Calculated
Your capital gains don’t sit in their own isolated bracket. They stack on top of your ordinary income. The IRS first fills the rate brackets with wages, interest, business income, and similar items, then places long-term gains and qualified dividends on top of that stack. Whatever bracket the gains land in sets the preferential rate.
A raise at work can push capital gains into a higher preferential tier even when investment income does not change. Suppose you’re a single filer with $40,000 in wages and $15,000 in long-term gains. Your ordinary income fills up to $40,000, then the first $9,450 of gains sits in the 0% zone (up to the $49,450 threshold). The remaining $5,550 spills into the 15% tier. The result is a split rate on what looks like a single batch of gains.
Special Rates for Specific Assets
A few categories break from the standard 0/15/20 structure.
Collectibles at 28%
Gains from selling collectibles held longer than one year face a maximum rate of 28%.6Office of the Law Revision Counsel. 26 US Code 1 – Tax Imposed The code defines collectibles to include artwork, rugs, antiques, metals, gems, stamps, coins, and alcoholic beverages.7Office of the Law Revision Counsel. 26 US Code 408 – Individual Retirement Accounts The 28% figure is a ceiling. If your ordinary rate would be lower, you pay the lower rate instead.
Depreciation Recapture on Real Estate at 25%
When you sell rental or business real estate at a profit, the IRS splits the gain in two. The portion tied to depreciation deductions you previously claimed is taxed at a maximum rate of 25%.8Office of the Law Revision Counsel. 26 USC 1 – Tax Imposed Any remaining profit above your original purchase price follows the normal long-term brackets.
Qualified Small Business Stock
Section 1202 offers the most generous treatment in the code. If you buy stock directly from a qualifying small business (a domestic C corporation with no more than $50 million in gross assets) and hold it long enough, a percentage of your gain is excluded from income entirely.9Office of the Law Revision Counsel. 26 US Code 1202 – Partial Exclusion for Gain from Certain Small Business Stock For stock acquired after July 4, 2025, the exclusion phases in: 50% after three years, 75% after four years, and 100% after five or more years. The per-issuer gain cap is the greater of $15 million (indexed for inflation) or ten times your adjusted basis in the stock. Stock acquired on or before July 4, 2025 follows older rules, with a five-year hold required for full exclusion and a $10 million per-issuer cap. Any gain that doesn’t qualify for the exclusion is taxed at the 28% collectibles rate, not the standard long-term rate.
The 3.8% Net Investment Income Tax
Higher earners face an additional 3.8% tax on investment income. It kicks in when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly, and applies to the lesser of net investment income or the amount by which income exceeds the threshold.10Internal Revenue Service. Net Investment Income Tax Combined with the 20% top preferential rate, the effective maximum federal rate on long-term gains and qualified dividends reaches 23.8%. The $200,000 and $250,000 triggers have not moved since 2013, so inflation has gradually pulled more taxpayers in.
Offsetting Gains with Capital Losses
Selling an investment at a loss can reduce the tax on your gains. The netting works in order: short-term losses first offset short-term gains, long-term losses first offset long-term gains. If either category still shows a net loss, it cancels out gains in the other.
If total losses exceed total gains for the year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately).4Internal Revenue Service. Topic No. 409, Capital Gains and Losses Anything beyond that carries forward indefinitely in $3,000 annual increments.
A long-term loss used against a short-term gain is especially valuable because it eliminates income that would otherwise be taxed at ordinary rates. A short-term loss against a long-term gain saves less, since the long-term gain already had a lower rate.
The Wash Sale Rule
The IRS won’t let you claim a loss if you buy a substantially identical investment within 30 days before or after the sale.11Office of the Law Revision Counsel. 26 USC 1091 – Loss from Wash Sales of Stock or Securities The 61-day window (30 days before, the sale date, 30 days after) exists to prevent booking a tax loss while keeping the same position. Sell a stock at a loss on Monday and repurchase the same stock Wednesday, and the loss is disallowed for that year.
The disallowed loss isn’t gone forever. It gets added to the cost basis of the replacement shares, so you’ll benefit when you eventually sell those. The rule covers stocks, bonds, mutual funds, and ETFs, and currently does not apply to cryptocurrency.
Reporting Requirements
Claiming preferential rates requires specific paperwork. Every sale of a capital asset is reported on Form 8949, listing the asset description, date acquired, date sold, proceeds, and cost basis.12Internal Revenue Service. Instructions for Form 8949 Sales and Other Dispositions of Capital Assets If your brokerage sent a 1099-B, the amounts on Form 8949 need to match or explain any discrepancy. The totals flow to Schedule D, which summarizes your overall capital gain or loss for the year.13Internal Revenue Service. About Schedule D (Form 1040), Capital Gains and Losses Brokerages are required to report cost basis for stocks purchased after 2011, but older holdings or assets transferred between accounts sometimes appear with a basis of zero. Keep your own purchase records, particularly for assets held across multiple accounts or many years.
State Taxes Can Add Significantly
Federal preferential rates are only part of the picture. Most states tax capital gains as ordinary income, with rates running from zero in states with no income tax up to 13.3% in the highest-tax states. Only a handful of states offer their own reduced rates for investment income. Combined federal and state rates on long-term gains can range from 0% to roughly 37% depending on where you live and how much you earn, so a large asset sale deserves state-level planning alongside the federal analysis.