Capital Gains 101: How to Build Wealth and Where to Fix the U.S. Tax Structure
Capital gains are the amount of money your money earns from investing. For example, if I invest $1,000 at the beginning of the year and end the year with $1,200, I have $200 in capital gains. When you break down this fancy terminology it makes sense: “capital” just means money, and “gains” means the amount of growth. Capital gains are the amount of growth my money experienced over a certain period of time.
One way to grow wealth is to invest your money and let it grow additional money to make your wealth increase. The other way to grow wealth is to exchange your time and energy for dollars by earning income from an employer or a client. In the first case, you invest money but none of your time or energy. In the second, you trade your time and energy for money. Both can net you more money than you originally had.
Letting your money earn more money is the better option. The first positive is obvious: You can earn money while you sleep, sail through Greece, or get a massage. But there is an additional perk to using your money to earn money rather than working to earn income. The American tax system is kinder to individuals who choose to have their money earn money than it is to Americans earning income.
Income Tax Rates
Whenever you earn money, it is considered taxable income. Many people do not realize how extensive taxes are. Legally, you need to pay taxes on the $10 you earned from a scratch-off lottery ticket or the $20 a friend gave your kid for watering the plants while on vacation. All income is taxable by default, unless specifically excluded by law.
At the federal level, the tax rates for 2025 income are:
Tax Rate | Single | Married Filing Jointly | Married Filing Separate | Head of Household |
10% | $0 – $11,925 | $0 – $23,850 | $0 – $11,925 | $0 – $17,000 |
12% | $11,926 – $48,475 | $23,851 – $96,950 | $11,926 – $48,475 | $17,001 – $64,850 |
22% | $48,476 – $103,350 | $96,951 – $206,700 | $48,476 – $103,350 | $64,851 – $103,350 |
24% | $103,351 – $197,300 | $206,701 – $394,600 | $103,351 – $197,300 | $103,351 – $197,300 |
32% | $197,301 – $250,525 | $394,601 – $501,050 | $197,301 – $250,525 | $197,301 – $250,500 |
35% | $250,526 – $626,350 | $501,051 – $751,600 | $250,526 – $375,800 | $250,501 – $626,350 |
37% | $626,351+ | $751,601+ | $375,801+ | $626,351+ |
To clarify, if you make $260,000 as a single taxpayer, it does not mean you pay 35% in federal taxes on all of your income despite barely clearing the 35% threshold. You pay 10% in federal taxes on the first $11,925, 12% on the next $36,549 (the money from $11,926 to $48,475), 22% on the next $54,874, and so on until you get to the final dollar. Only $9,474 is taxed at that 35% tax rate, since only dollars earned above $250,525 are taxed at 35% federally. While people often refer to their tax bracket as the highest taxes they must pay, this is their marginal tax rate, or the tax rate they must pay on the last few dollars. This is higher than their effective tax rate, the average of all tax rates paid per dollar.
The amounts in the table above refer to taxable income, not gross income. Your taxable income is the amount of your gross income that gets taxed after subtracting your standard deduction or itemized deductions.
The tax rates get pretty high, especially for those making just under $200,000 (or j$400,000 for married couples filing jointly). Most Americans are okay with that because taxing individuals and families with higher incomes makes sense to the average person. Those earning more than they need should pay to help those who are unable to earn enough.
What that logic misses is that the highest earners are not earning income at all. They instead hold numerous investments that earn capital gains, and capital gains are not taxed at these levels. They are taxed at much lower levels.
Capital Gains Taxes
Capital gains, the earnings you receive from your investments, are still income. However, they have two key differences from wage income: (1) the tax rates are lower, and (2) the timing of paying capital gains taxes is much more flexible.
Here are the 2025 federal capital gains tax rates, based on your total taxable income:
Tax Rate | Single | Married Filing Jointly | Married Filing Separate | Head of Household |
0% | $0 – $48,350 | $0 – $96,700 | $0 – $48,350 | $0 – $64,750 |
15% | $48,351 – $533,400 | $96,701 – $600,050 | $48,351 – $300,000 | $64,751 – $566,700 |
20% | $533,401+ | $600,051+ | $300,001+ | $566,701+ |
** This does not include the net investment income tax (a 3.8% surtax on investment income above a certain threshold based on filing status).
Like regular income tax, capital gains taxes are taxed at marginal rates. But look at the different thresholds for tax rates! If someone works a job and makes $50,000 in income as a single taxpayer, the last $1,524 of their earnings will be taxed at 22%. Meanwhile, earning $50,000 in capital gains would mean most of those gains were not taxed at all, and only the last $1,650 would be taxed at 15%. If their money earns money instead, even if they earned $1,000,000, they would still only be taxed at 20%!
To put a dollar figure on that, if you have $50,000 in taxable wage income, you pay $5,914 in federal income tax. If your money is invested and you have $50,000 in taxable capital gains, you pay $247.50. Earning $50,000 in income rather than earning $50,000 in capital gains means paying nearly 24x more in taxes.
Timing of Taxes
The generous tax rates for capital gains are only the first half of the equation. Timing also matters.
I almost certainly had $50,000 in capital gains last year, but I did not have to pay even $247.50 in capital gains taxes because I kept all my money invested. Capital gains taxes only come into effect when you sell all or part of your investment. It can grow for years, earning six-figures, seven-figures, or more in gains without requiring you to pay any taxes on it. Capital gains taxes are only paid when you liquidate your investment.
This gives an investor a lot of control over when they pay taxes. That matters because I will not choose to withdraw $1,000,000 at once in a year where I also have a six-figure income. Instead, I can withdraw money in small increments—for example, any increment lower than $96,700 as someone who is married filing jointly. I can also opt to withdraw during years when I do not have an income, or have a very small income, to avoid taxes.
This is how people can retire early. When we both stop earning income entirely, we can have up to $96,700 in taxable income every year without paying any capital gains taxes at all. With a standard deduction of $31,500 in 2025, this can mean no federal taxes on nearly $130,000 of capital gains because our money earned the money instead of us earning income.
Building Wealth with Capital Gains
If you are a normal person looking to live a rich life within reason, you should absolutely use capital gains to help you on your journey! Investing early means you have to earn less money over the course of your lifetime because your money will earn more money rather than you earning an income. It also means fewer taxes on that money because when your money makes money, the first significant part of the money is tax-free. It is completely reasonable to live off capital gains before any capital gains taxes kick in, something that is not true for income tax.
As a couple, we could realize $128,200 in capital gains without paying any taxes (assuming no other income) with the standard deduction. If we earned that same amount in wages, we would pay $11,127 in federal income tax.
“Realized” is the tax term for capital gains when you sell an investment, while “unrealized” gains are those still in your account. For example, if you purchased mutual fund shares for $100, and the value grows to $120, you have $20 in unrealized capital gains, which become realized (and taxed) when you sell them. In this example, you are only taxed on $20 when you sell your investment, not the full $120 you get when selling.
Because only realized gains are taxed, rather than the full amount withdrawn, a married couple filing jointly could potentially withdraw considerably more than $128,200 from their investments without paying federal income tax.
We love helping individuals achieve FIRE (financial independence, retire early) with a strategy to use capital gains to support their lifestyle while staying below the taxable threshold. Some of the “Fat FIRE” households can replicate this strategy by making sure they minimize withdrawals at the 15% tax rate. They can also get creative and withdraw some funds that have experienced a capital loss, meaning those specific investments went down over time, to counteract capital gains. These types of financial strategies can help you rely on income less, work less overall, and enjoy the money you already earned!
The Negative Consequences of Capital Gains
Despite creating positive opportunities for individuals and households that want to build a sensible amount of wealth, the current tax structure also encourages the extremely wealthy to keep building wealth at increasingly ridiculous levels. For me, generous capital gains taxes meant I wanted to invest $1,000,000 as fast as possible and get out of the income-earning game in favor of letting my money earn capital gains that I could enjoy tax-free. Many extremely wealthy individuals do not share that mindset. Instead, the friendly tax schedule for capital gains encourages them to invest exorbitant amounts of money and pay only a 20% marginal tax rate on their billions of dollars in capital gains.
When policymakers look at reforming the tax structure to redistribute wealth, they usually look at two possibilities. The first is raising income tax rates on the wealthiest individuals. This largely fails because the wealthiest individuals in the world are not earning the majority of their money from wages! Their money is invested and earning money. You could throw a 75% tax rate on individuals with income above $750,000, and this would not bother most billionaires. (The highest marginal federal tax rate exceeded 90% in the middle of the twentieth century.)
The second suggestion is a wealth tax. Conceptually, this makes much more sense. In practice, a wealth tax is far too complicated. A wealth tax is usually suggested by individuals who have no concept of the diversity of assets of the wealthy. If you think you calculate someone’s wealth by adding together all their financial accounts, the equity in their home, and the value of a few expensive goods like a car and that diamond jewelry set, you are missing so much. How do you value a Monet owned by the same family for 100 years that has never been up for auction? What about the dinosaur skeleton owned for generations and likely acquired from the goods stolen by the Nazis during World War II? Or the car that the owner put hours into building specially to accommodate their height and disability? These are real things rich people own.
You may even own some of these quirky-yet-valuable items yourself. I have no idea what value someone would give the shrapnel that became caught in my grandfather’s parachute in World War II or his hat for the Korean War with the extra tick marks showing he flew an extra two missions beyond the normal rotation out. They have emotional value to me because that parachute saved my grandfather’s life from that piece of shrapnel and is the only reason my mom and I would eventually exist. They may also have some value to a museum or historian, but I am not giving them away, so there is no need for me to determine their value. (I do know that I was once offered $2,000 for a vintage Red Sox hat that used to belong to my grandfather, but I am not selling that either.)
Calculating someone’s wealth is always complicated, and it gets more complicated when they are extremely wealthy and have eccentric possessions that do not neatly fall into valuation categories. Wealth is not all money, jewelry, houses, boats, and planes. Someone’s net worth includes Winston Churchill’s false teeth, and someone else may secretly have pieces of the original Amber Room from Catherine’s Palace. (If you do have pieces of the original Amber Room, please let me know because I would love to see them.)
Higher income taxes on the highest incomes will not help economic inequity. A wealth tax is too unwieldy and will just encourage billionaires to do things like move their Picasso to their superyacht to avoid paying taxes on it. The tax structure that could actually help redistribute wealth a little bit is a capital gains restructure.
Many regular people or even “regular wealthy” people—think those who retired after owning a business into their 50s, sold the business and now have $10 million—argue against changing the capital gains tax rates because they paid income taxes for their whole life and now want to enjoy their money. They should! I love the idea of encouraging investing with low capital gains taxes for those with reasonable amounts of wealth invested. If that person with $10 million wants to withdraw $1 million, I am not suggesting raising the 20% capital gains tax on them.
But it feels wrong that capital gains taxes stop at 20%, even if you are withdrawing billions, when income taxes rise to 37%. I cannot understand the rationale in taxing $1 billion in capital gains at a 20% rate. Surely some scale exists where we could increase capital gains taxes on capital gains surpassing $1 million. The increase could be slow, but there is absolutely no justification for not reaching that 37% tax rate by the time someone experiences billions of dollars in capital gains. I would suggest the tax rate reaching around 50% by the time we get to ten-figure capital gains, but we could disagree on that detail. Either way, extreme capital gains should be taxed at higher levels. Those building sensible amounts of individual wealth should remain untouched, but those wealthier than some countries should pay more than a 20% tax rate.
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