What Are Arizona’s Capital Gains Tax Rules?
Understand how Arizona treats capital gains as ordinary income and the specific state-level subtractions available to reduce your taxable amount.
A capital gain represents the profit realized from the sale of an asset, such as stocks, bonds, or real estate. This article explains how Arizona handles the taxation of these gains for state income tax purposes, providing clarity on its unique approach compared to federal rules.
Arizona’s Approach to Taxing Capital Gains
Arizona does not maintain a separate tax system for capital gains. Instead, it includes capital gains as part of your regular taxable income. 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 consolidated with your other income.
The state has adopted a flat tax structure, which simplifies the calculation. Arizona applies a single income tax rate of 2.5% to all taxable income, regardless of the total amount. This flat rate applies equally to the portion of your income derived from capital gains.
This methodology contrasts with the federal system, where a distinction is made between short-term and long-term capital gains. Federally, short-term gains are taxed at ordinary income tax rates, which are progressive and range from 10% to 37%. Long-term capital gains, however, often benefit from lower preferential rates of 0%, 15%, or 20%, depending on your total taxable income and filing status. Arizona’s system, by treating all gains as ordinary income, presents a different calculation for taxpayers.
Calculating Your Arizona Taxable Gain
The initial step in determining your taxable gain is the same for both federal and state purposes. You must calculate the basic capital gain using the formula: Sale Price – Adjusted Basis = Capital Gain. The adjusted basis is typically the original cost of the asset, plus any improvements, minus depreciation.
Arizona law provides a modification for certain long-term capital gains through a specific subtraction. Taxpayers can exclude 25% of the net long-term capital gain derived from assets acquired after December 31, 2011. To qualify, the asset must have been held for more than one year before being sold.
For example, imagine you sold a qualifying stock and realized a long-term capital gain of $20,000. You would first calculate the Arizona-specific subtraction, which is 25% of the gain, or $5,000 ($20,000 x 0.25). This amount is then subtracted from your total gain, leaving a net taxable gain for Arizona purposes of $15,000 ($20,000 – $5,000). It is this reduced amount that is added to your other income and taxed at the state’s 2.5% flat rate.
Reporting Capital Gains on Your Arizona Tax Return
The process of reporting capital gains on your Arizona tax return begins with your federal return. Your federal Adjusted Gross Income (AGI), which includes the full amount of your capital gains, is the starting point for your state tax calculation. This figure is transferred directly to your Arizona Resident Income Tax Return (Form 140), Part-Year Resident Return (Form 140PY), or Nonresident Return (Form 140NR).
After transferring your federal AGI, you must make the specific Arizona adjustments. The 25% capital gain subtraction is calculated using a specific worksheet for this purpose. The resulting exclusion amount is then entered on the appropriate line of your Arizona tax return.
This subtraction reduces your Arizona taxable income. This final adjusted figure is what the 2.5% tax rate is applied to, completing the process of reporting and paying state tax on your capital gains.