How Does Arizona Tax Capital Gains?

A capital gain represents the profit realized from the sale of an asset, such as stocks, bonds, or real estate. This gain is the difference between the asset’s selling price and its original purchase price, with adjustments for any improvements or depreciation. While the federal government taxes these gains, each state has its own distinct approach. The taxation of capital gains at the state level can influence an investor’s net return.

How Arizona Taxes Capital Gains

Arizona does not have a separate tax rate specifically for capital gains. Instead, the state treats profits from the sale of assets as ordinary income. This means that both short-term gains, from assets held for one year or less, and long-term gains, from assets held for more than a year, are added to a taxpayer’s other sources of income, such as wages, salaries, and interest. The combined total is then taxed at Arizona’s single flat income tax rate.

As of the 2023 tax year, Arizona implemented a flat tax rate of 2.5% for all individual income taxpayers, regardless of their income level. This rate is a change from its previous graduated-rate structure and is one of the lowest flat tax rates in the country. This approach differs from the federal system, which applies preferential, lower rates to long-term capital gains.

While all capital gains are initially treated as ordinary income, Arizona offers a deduction for certain long-term gains, which effectively lowers the tax burden on those specific profits. This subtraction is not a different tax rate but rather a reduction of the taxable income amount itself.

Calculating Your Arizona Taxable Gain

The process of calculating the taxable gain for Arizona purposes begins with federal tax rules. Arizona’s state income tax return uses the Federal Adjusted Gross Income (AGI) as its starting point. The fundamental calculation involves subtracting the asset’s adjusted basis from its sale price.

An asset’s adjusted basis is its original cost plus the value of any subsequent capital improvements, less any depreciation that has been claimed. For example, if you purchased a property for $300,000 and spent $50,000 on a major renovation, your adjusted basis would be $350,000. If you later sell that property for $500,000, your federally calculated capital gain is $150,000. This gain is reported on federal Schedule D and becomes a component of your Federal AGI.

Once the Federal AGI is determined, that figure is transferred to the Arizona individual income tax return. This federally calculated number, which includes the full amount of any net capital gains, serves as the initial figure for calculating Arizona taxable income. From this starting point, taxpayers then make specific additions and subtractions based on Arizona’s own tax laws to arrive at the final amount of income subject to the state’s 2.5% tax.

Arizona-Specific Capital Gains Subtractions

Arizona provides a tax benefit through a specific subtraction for certain long-term capital gains. Taxpayers are permitted to subtract 25% of the net long-term capital gain that is included in their Federal AGI, provided the gain is derived from assets acquired after December 31, 2011. This subtraction directly reduces the amount of income that is subject to Arizona’s tax, effectively lowering the tax rate on qualifying gains to 1.875%.

The acquisition date is the primary factor in determining eligibility for this subtraction. For instance, if an investor realizes a $20,000 long-term capital gain from selling stock purchased in 2015, they can subtract $5,000 (25% of $20,000) from their Arizona gross income. If the same stock had been purchased in 2010, no subtraction would be allowed.

This subtraction applies to gains from a wide range of capital assets, including stocks, bonds, real estate, and business interests. Taxpayers must carefully track the acquisition dates of their assets to correctly claim this deduction.

Reporting Capital Gains on Your Arizona Tax Return

To report capital gains and any related subtractions, Arizona taxpayers will primarily use Form 140, the Resident Personal Income Tax Return. The process begins by entering your Federal Adjusted Gross Income (AGI) on the designated line of this form. This AGI figure, which you will have already calculated for your federal return, includes the total amount of your net capital gains for the tax year.

If you have a qualifying long-term capital gain from an asset acquired after December 31, 2011, you must claim the 25% subtraction to receive the tax benefit. This is not an automatic deduction. The subtraction is reported on the Arizona Schedule of Additions and Subtractions, which is filed alongside Form 140. You will calculate the 25% deductible amount and enter it on the specific line designated for this capital gain subtraction.

The total from the subtractions schedule then flows back to the main Form 140, where it reduces your Arizona gross income. You must complete this schedule accurately and retain records, such as brokerage statements or settlement documents, that verify the asset’s acquisition date and the calculated gain.