State of Michigan Capital Gains Tax Rules

A capital gain represents the profit realized from the sale of an asset, such as stocks, bonds, or real estate. In Michigan, these gains are subject to state taxation. The state does not have a separate tax specifically for capital gains but instead includes them as a component of a taxpayer’s total income for the year. The process begins with the federal determination of the gain, which then flows through to the state tax return where it is subject to Michigan’s specific rules and rates.

How Michigan Taxes Capital Gains

Michigan’s approach to taxing capital gains begins with the federal Adjusted Gross Income (AGI). The AGI calculated on a federal income tax return, which includes the net total of all capital gains and losses, serves as the starting point for the Michigan income tax return. This simplifies the initial calculation, as the federal rules for determining the amount of the gain are followed.

Unlike the federal system, which applies different tax rates to short-term and long-term capital gains, Michigan makes no such distinction. At the federal level, gains on assets held for more than one year are taxed at lower, preferential rates. In Michigan, all net capital gains, regardless of the holding period, are treated as ordinary income. This income is then subject to the state’s flat income tax rate.

For the 2024 tax year, Michigan’s flat income tax rate is 4.25 percent. This single rate is applied to a taxpayer’s total taxable income, which includes wages, interest, and all net capital gains. The lack of a preferential rate for long-term gains means that the profit from selling a long-held asset is taxed at the same rate as regular salary or wages earned during the year.

Michigan Specific Capital Gains Adjustments

While Michigan taxes capital gains as income, it offers several specific subtractions that can reduce the total amount of taxable income, including gains. One subtraction relates to retirement and pension benefits, which can include capital gains from investments held within retirement accounts like a 401(k) or an IRA. The rules for this subtraction are tiered by the taxpayer’s year of birth, as Public Act 4 of 2023 initiated a phase-out of the tax on this income.

For the 2024 tax year, taxpayers born after 1945 and before 1963 can elect to deduct up to 50% of the maximum retirement income deduction amount available to the oldest retirees. For 2025, this deduction increases to 75% for taxpayers born before 1967. By the 2026 tax year, all taxpayers will be able to deduct the maximum amount, regardless of their birth year. These subtractions are not unlimited and are subject to specific annual thresholds that are adjusted for inflation.

Michigan also conforms to the federal principal residence exclusion found in Internal Revenue Code Section 121. This allows a taxpayer to exclude from income a significant portion of the capital gain from the sale of their main home. For federal purposes, single filers can exclude up to $250,000 of gain, and married couples filing jointly can exclude up to $500,000. Because Michigan starts with federal AGI, any gain excluded on the federal return is automatically excluded from Michigan income as well.

Another subtraction is for income derived from U.S. government obligations. Interest and capital gains from the sale of U.S. Treasury bonds, notes, and bills are taxable at the federal level but are exempt from state income tax. Taxpayers can subtract the amount of capital gain attributable to these specific federal securities from their Michigan income.

Reporting Capital Gains on Michigan Tax Forms

The process of reporting capital gains for Michigan tax purposes is integrated into the state’s standard individual income tax return, the MI-1040. The starting point for this form is the federal AGI, which already contains the net capital gain or loss calculated on the federal Schedule D.

Any Michigan-specific adjustments, such as the subtractions for retirement income or gains from U.S. government obligations, are not made directly on the MI-1040 itself. Instead, these are detailed on a separate form, Schedule 1, Additions and Subtractions. For example, the allowable retirement and pension benefit subtraction, which may include capital gains from an IRA distribution, is calculated and entered on this schedule. Similarly, gains from the sale of federal bonds would be listed as a subtraction on Schedule 1.

The net result from Schedule 1, which is the total of all Michigan-specific subtractions minus any required additions to income, is then transferred to the MI-1040. This total adjustment amount either decreases or increases the federal AGI to arrive at Michigan taxable income. In cases where a taxpayer has unique capital gains situations, such as gains from before Michigan’s income tax was enacted in 1967, they may need to file Form MI-1040D, Adjustments of Capital Gains and Losses, to properly calculate the Michigan-specific portion of the gain.