Arizona Capital Gains Tax Rules and Rates

A capital gain is the profit realized from the sale of an asset, such as stocks, bonds, or real estate. When you sell an asset for more than its original purchase price, the difference is a capital gain. The process for taxing these gains in Arizona involves starting with your federal income calculations and then making specific adjustments based on state law.

How Arizona Taxes Capital Gains

Arizona does not have a separate tax system for capital gains. Instead, it includes capital gains as part of your regular income, subjecting them to the state’s single flat income tax rate of 2.5%. Both short-term gains from assets held one year or less and long-term gains from assets held for more than a year are taxed at this same rate.

This approach differs from the federal tax system, which applies preferential rates to long-term capital gains. Federally, long-term gains are taxed at 0%, 15%, or 20%, depending on your total taxable income. In Arizona, the profit from selling an asset is added to your other income, and the total is taxed at the 2.5% rate.

Arizona Capital Gains Subtractions

Arizona law allows for an adjustment that can lower the state tax on certain investment profits. Taxpayers can subtract 25% of a net long-term capital gain from their Arizona gross income, provided the gain is from an asset acquired after December 31, 2011. This subtraction reduces the effective tax rate on qualifying gains to 1.875%.

The requirements for this subtraction are that the gain is classified as a net long-term capital gain for federal tax purposes and that the asset was acquired after December 31, 2011. The law does not impose additional qualifications based on the type of asset or its location, so the subtraction applies to gains from investments like stocks, bonds, and collectibles.

Calculating Your Arizona Taxable Gain

The calculation of your taxable capital gain in Arizona begins with your federal Adjusted Gross Income (AGI) from Form 1040. Your federal AGI already includes the full amount of any capital gains. From this starting point, you apply Arizona-specific adjustments to determine your Arizona taxable income.

To illustrate, consider a taxpayer with a $10,000 net long-term capital gain from stock purchased in 2015. Since this gain meets the criteria, the taxpayer can claim the 25% subtraction. The subtraction amount is $2,500 (25% of $10,000), which is then subtracted from the federal AGI on the Arizona tax return.

This adjustment reduces the income subject to Arizona’s 2.5% flat tax. In the example, only $7,500 of the original $10,000 gain would be included in the final Arizona taxable income. This calculation is performed separately from federal tax calculations, where the entire $10,000 gain is subject to the applicable federal long-term capital gains rate.

Reporting Capital Gains on Your Arizona Tax Return

For most individuals, reporting capital gains involves using Arizona Form 140, the Resident Personal Income Tax Return. The gain is included in the federal AGI that you report on the first line of this form.

The adjustment for qualifying long-term capital gains is claimed as a subtraction from income using the Arizona Schedule of Adjustments to Income. On this schedule, you will find a specific line and code for the capital gain subtraction. You must enter the calculated subtraction amount in the appropriate field.

The total subtractions from this schedule are then transferred to the designated line on Form 140, reducing your Arizona gross income. Failure to properly document this subtraction on the schedule with the correct code will result in the gain being taxed at its full value.