How Are Capital Gains Taxed in Michigan?

When you sell an asset like stocks, bonds, or real estate for more than you paid for it, the profit you make is called a capital gain. This profit is a form of income subject to taxation. The tax treatment of capital gains varies between the federal government and individual states, and this article explains the specific rules for how capital gains are taxed in Michigan.

How Michigan Taxes Capital Gains

Michigan does not have a separate tax rate specifically for capital gains. Instead, the state treats all capital gains as ordinary income, adding the profit to your other income sources like wages. This combined amount is then taxed at Michigan’s single flat income tax rate of 4.25% for the 2024 tax year. This approach simplifies state taxes by not distinguishing between short-term and long-term gains, a key difference from the federal system.

The foundation of your Michigan income tax return is your Federal Adjusted Gross Income (AGI). This figure, calculated on your federal Form 1040, already includes the net capital gain or loss you are required to report to the IRS. Michigan uses this federal AGI as the starting point for its own tax calculation, meaning the federally calculated gain flows directly onto your Michigan return before any state-specific adjustments are made.

Calculating Your Capital Gain

Before a capital gain can be taxed in Michigan, it must first be calculated at the federal level. The formula for this calculation is the sale price of the asset minus its adjusted basis. The result is either a capital gain if the sale price is higher, or a capital loss if it is lower. The adjusted basis represents your total investment in the asset for tax purposes.

An asset’s adjusted basis starts with its original cost, which includes the purchase price and any associated fees, such as commissions. This initial basis is then increased by the cost of any significant improvements or reinvested dividends and decreased by items like depreciation if the asset was used for business. For real estate, improvements that add to the property’s value, like a new roof, increase the basis. For stocks, the basis is the purchase price plus any brokerage commissions.

The federal government distinguishes between two types of capital gains based on how long you owned the asset. A short-term capital gain results from the sale of an asset held for one year or less, while a long-term capital gain comes from an asset held for more than one year. This distinction is for your federal return, where short-term gains are taxed at ordinary federal income rates, while long-term gains are taxed at lower, preferential rates. Although Michigan does not differentiate between the two, this federal classification still matters because the final net capital gain included in your Federal AGI is determined by these federal rules.

Michigan-Specific Adjustments and Deductions

After establishing your Federal AGI, which includes your net capital gains, Michigan law allows for certain subtractions that can reduce your taxable income. These adjustments are detailed on Michigan’s Schedule 1. A significant subtraction available to many residents is related to retirement and pension benefits, which can indirectly affect the taxation of capital gains realized within retirement accounts like a 401(k) or an IRA.

Under a law known as the “Lowering MI Costs Plan,” Michigan is phasing out the tax on most retirement and pension income. This change, enacted as Public Act 4 of 2023, is being implemented over a four-year period that began with the 2023 tax year and will be fully effective by 2026. The amount of the deduction you can take depends on your birth year. For example, for the 2024 tax year, taxpayers born between 1946 and 1962 may be eligible to deduct a portion of their retirement income.

Taxpayers must review the specific eligibility requirements based on their age and the source of their income to determine the exact amount they can subtract on Schedule 1.

Reporting Capital Gains on Your Michigan Tax Return

The process of reporting capital gains on your Michigan tax return uses numbers that have already been calculated for your federal return. Your starting point is the main Michigan Individual Income Tax Return, Form MI-1040. On this form, you will enter your Federal Adjusted Gross Income (AGI), which already has your net capital gain or loss for the year factored into it.

Next, you will complete Michigan Schedule 1, titled “Additions and Subtractions.” This is where you will claim any Michigan-specific deductions you are eligible for, such as the retirement and pension benefits subtraction. After detailing all applicable subtractions on Schedule 1, you will enter the final amount on your MI-1040. This total subtraction amount reduces your AGI, thereby lowering your final Michigan taxable income.