Capital Gains Tax in Arizona: Everything You Need to Know

In Arizona, the current capital gains tax rate is 2.5%. This article will explore the capital gains tax in Arizona, discuss hypothetical investment scenarios, and explore a few ways that you can reduce capital gains tax. 

Contact the ARQ Wealth team for more detailed tax planning advice for Arizona residents. While we are not CPAs and do not file tax returns, we can help you maximize your tax savings with strategic planning. Call us at (480) 214-9572 or use our contact form.

What is Capital Gains Tax?

Capital gains tax is a tax owed to the government on any profit you make from selling assets. A capital gain (or loss) is the difference between the price you bought an asset for and the price 

you sold it for. Your total capital gains tax liability depends on the total assets you sold, how long you owned them before selling, your taxable income, and your filing status.

There are two main types of capital gains tax:

• Short-term capital gains: Gains from an asset you held for less than one year before selling. 
• Long-term capital gains: Gains from an asset you held for longer than one year before selling.

You’re usually required to pay both federal and state taxes on any capital gains income. The federal government taxes long-term capital gains at 0%, 15%, or 20%, depending on your income level. However, short-term federal capital gains tax is taxed the same as regular income tax and varies depending on your income level.

Arizona, fortunately, takes a simplified approach to capital gains tax.

Arizona Capital Gains Tax: 2.5%

Arizona does not differentiate between long-term and short-term capital gains. Instead, it treats all capital gains as regular income and taxes them at the state income tax rate of 2.5%.

Arizona also provides a 25% deduction for gains on assets acquired after December 31, 2011, and held for longer than a year. This effectively reduces the state’s long-term capital gains tax rate to just 1.875%, according to the Tax Foundation.

Let’s look at two examples of how Arizona taxes capital gains.

Arizona Short-Term Capital Gains Example

Let’s say you invested $10,000 in Company A and six months years later that investment was worth $20,000. You decide to sell your investment and realize a gain of $10,000 ($20,000 – $10,000 = a $10,000 gain). Because you held this investment for less than one year it counts as a short-term investment.

Step 1: Apply Arizona’s flat 2.5% tax rate to your gain

Take your new taxable gain and apply the 2.5% tax rate: $10,000 x 0.025 = $250. You’d owe a total state capital gains tax of $250 on this investment gain.

Arizona Long-Term Capital Gains Example

Let’s say that you invested $10,000 in Company A and five years later that investment was worth $20,000. You decide to sell your investment and realize a gain of $10,000 ($20,000 – $10,000 = a $10,000 gain). Because you held this investment for longer than one year it counts as a long-term investment.

Step 1: Apply the 25% deduction: 

Arizona residents are eligible to deduct 25% from their long-term gain: $10,000 x 0.25 = $7,500

Step 2: Apply Arizona’s flat 2.5% tax rate:

Take your new taxable gain and apply the 2.5% tax rate: $7,500 x 0.025 = $187.50. You’d owe a total state capital gains tax of $187.50 on this investment gain.

How Does Arizona Compare?

Arizona’s 1.875% long-term capital gains tax is fairly low compared to most other states. 

Eight states do not levy a long-term capital gains tax. Those states are Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, and Wyoming. 

Other states with low long-term capital gains taxes include: 

1. North Dakota taxes capital gains at a rate of 1.50%
2. Arkansas taxes capital gains at a rate of 2.20%
3. Indiana taxes capital gains at a rate of 3.05%
4. Ohio taxes capital gains at a rate of 3.50%
5. Kentucky taxes capital gains at a rate of 4.00%
6. Montana taxes capital gains at a rate of 4.10%
7. Louisiana taxes capital gains at a rate of 4.25%
8. Illinois taxes capital gains at a rate of 4.95%
9. Alabama taxes capital gains at a rate of 5.00%
10. Georgia taxes capital gains at a rate of 5.49%

Comparatively, states with a high long-term capital gains tax include:

1. District of Columbia taxes capital gains at a rate of 10.75%
2. New York taxes capital gains at a rate of 10.90%
3. California taxes capital gains at a rate of 13.30%

Capital Gains Tax: What Else to Know

Here are a few other crucial pieces of information to know related to how Arizona taxes capital gains:

1. Unrealized vs. realized gains: You do not owe capital gains taxes on an investment until you sell it. Prior to selling the asset, all gains are “unrealized” and therefore untaxed. You won’t owe taxes on any gains until you sell the asset and “realize” the gain. There are many ways to use this to your advantage such as strategically selling losing investments to offset your tax liability, a strategy known as tax loss harvesting.

2. You can offset your income with capital losses: While you have to pay a tax on any capital gains, you can also leverage capital losses to help offset your income. For example, if you sold one stock for a $6,000 profit and another for a $10,000 loss then your net capital gain is actually -$4,000. Since your total investment gains were net negative, you won’t owe any capital gains taxes and can actually deduct up to $3,000 in net capital losses from other forms of income, like your salary or interest income.

3. You can avoid capital gains taxes with retirement accounts: You do not have to pay capital gains tax if you use retirement accounts that use after-tax dollars, like Roth IRAs. However, you still have to pay capital gains tax on retirement accounts that use pre-tax dollars, like traditional 401(k)s. To understand which retirement accounts can help you avoid paying capital gains tax, be sure to speak with an Arizona-based wealth management professional.

Final Thoughts: Capital Gains Tax in Arizona

Arizona treats capital gains as ordinary income and taxes them at the state’s regular income tax rate of 2.5%. For long-term capital gains, Arizona also offers a 25% deduction, which effectively lowers the state’s capital gains tax to just 1.875%.

In addition to a low capital gains tax, Arizona offers favorable tax treatment to residents in the following ways: 

1. No estate tax
2. A low income tax rate of just 2.5%
3. Tax credits for charitable donations or contributions 
4. A relatively low cost of living

Overall, Arizona is growing more popular among retirees and investors due to its affordable tax laws and attractive lifestyle options. 

We hope that you’ve found this article valuable when it comes to learning about capital gains tax in Arizona. If you have any questions about tax planning in Arizona, please be sure to contact the ARQ Wealth team.