Capital gains earned by an S corporation are generally not taxed at the corporate level. They pass through to shareholders and are taxed on personal returns, so the S corp capital gains tax rate you actually pay is your individual rate: 0%, 15%, or 20% for long-term gains, or 10% to 37% for short-term gains, depending on your total taxable income and filing status. One exception matters: a former C corporation that sells appreciated assets within five years of electing S status owes a 21% built-in gains tax at the entity level before anything passes through.
Why Pass-Through Character Matters
An S corporation files Form 1120-S but does not pay federal income tax on most of its earnings.1Internal Revenue Service. About Form 1120-S Income, losses, deductions, and credits flow to shareholders based on ownership percentage. A 40% owner gets 40% of everything.
Capital gains are “separately stated items,” which means they keep their character as capital gains when they land on your personal return.2Office of the Law Revision Counsel. 26 USC 1366 – Pass-Thru of Items to Shareholders Without that rule, gains would be buried inside ordinary business income and taxed at ordinary rates. The S corporation reports your share on Schedule K-1, and you carry the numbers to your Form 1040.3Internal Revenue Service. 2025 Shareholder’s Instructions for Schedule K-1 (Form 1120-S)
One point trips people up. You owe tax on your allocated share of gains whether or not the corporation actually distributes the cash. If the business books a $200,000 capital gain and reinvests every dollar, you still pay tax on your slice out of pocket.
Long-Term vs. Short-Term Rates for 2026
The rate depends on how long the S corporation held the asset before selling it. Assets held one year or less generate short-term gains, taxed at your ordinary income tax rate. Ordinary rates for 2026 run from 10% to 37%.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Short-term gains get no preferential treatment; they stack on top of your other income.
Assets held more than one year produce long-term gains, taxed at 0%, 15%, or 20%.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses Which bracket applies depends on your total taxable income and filing status. For 2026, the thresholds are:6Internal Revenue Service. Revenue Procedure 2025-32
- Single filers: 0% on taxable income up to $49,450; 15% from $49,451 to $545,500; 20% above $545,500.
- Married filing jointly: 0% up to $98,900; 15% from $98,901 to $613,700; 20% above $613,700.
- Married filing separately: 0% up to $49,450; 15% from $49,451 to $306,850; 20% above $306,850.
- Head of household: 0% up to $66,200; 15% from $66,201 to $579,600; 20% above $579,600.
Most S corporation shareholders land in the 15% bracket. The 0% rate is real but requires modest total taxable income, and the 20% rate only kicks in at high thresholds.
Higher Rates on Collectibles and Depreciated Real Estate
Two categories of long-term gains carry higher ceilings, and both pass through with that special character intact.
Collectibles held more than a year, including art, coins, and antiques, are taxed at a maximum rate of 28%.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses Most S corporations never touch this rate, but it matters for businesses holding valuable collections.
Depreciable real property produces a separate layer called unrecaptured Section 1250 gain, taxed at a maximum of 25%.5Internal Revenue Service. Topic No. 409, Capital Gains and Losses This recaptures the benefit of prior depreciation deductions on the building. If your S corporation owns commercial real estate, expect this rate to appear when the property sells.
The 3.8% Net Investment Income Tax
Higher-income shareholders may owe an additional 3.8% surtax on net investment income. The tax applies when modified adjusted gross income exceeds $200,000 for single filers or $250,000 for married couples filing jointly.7Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
Whether your S corporation gains get hit turns on how involved you are in the business. Gain from property used in a trade or business where the shareholder materially participates is generally excluded from net investment income.8eCFR. 26 CFR 1.1411-4 – Definition of Net Investment Income So if you actively run the S corporation and the company sells equipment at a profit, that passed-through gain usually escapes the surtax.
The NIIT is more likely to apply in these situations:
- Passive shareholders. If you own stock but do not materially participate, your share of gains is passive activity income and counts as net investment income.
- Investment income inside the S corp. Gains on stocks, bonds, or rental property held by the corporation (where you don’t materially participate) are generally net investment income regardless of your role in the operating business.
- Selling your S corporation stock. Gain from selling S corporation shares is generally net investment income, though special rules can reduce the taxable amount if the corporation conducts a trade or business in which you materially participate.
For a passive shareholder above the threshold, the worst-case combined federal rate on long-term gains is 23.8% (20% plus the 3.8% surtax). Active owner-operators often avoid the NIIT entirely on operating gains, leaving the ceiling at 20%.
The Built-In Gains Tax
The one meaningful exception to pass-through treatment applies to former C corporations. When a C corporation converts to S status and then sells appreciated assets within five years, the S corporation itself owes a corporate-level tax called the built-in gains tax.9Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains The rule exists to stop companies from converting to S status just to dodge the corporate tax on gains that accrued during their C corporation years.
On the day the S election takes effect, the fair market value of every asset is fixed. The difference between that value and adjusted tax basis is the built-in gain. If the corporation sells any of those assets during the five-year recognition period, the pre-conversion portion of the gain is subject to the BIG tax at a flat 21%, the top corporate rate. Net operating loss and business credit carryforwards from the C years can offset the tax, so the actual bill may run lower.9Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains
After the corporation pays the BIG tax, the remaining gain passes through to shareholders. On a $100,000 built-in gain with a $21,000 BIG tax, the leftover $79,000 flows to K-1s and gets taxed again at each shareholder’s personal capital gains rate. The five-year clock is absolute. Once the recognition period expires, appreciated assets can be sold without any entity-level BIG tax, no matter how much pre-conversion appreciation remains.
The same rule reaches assets an S corporation receives from a C corporation in tax-free transactions where basis carries over. The five-year clock runs from the date of that transfer.9Office of the Law Revision Counsel. 26 USC 1374 – Tax Imposed on Certain Built-In Gains
Excess Passive Income Tax
A second entity-level tax hits S corporations still carrying accumulated earnings and profits from prior C corporation years. If more than 25% of gross receipts come from passive investment income (interest, dividends, rents, royalties, and similar), the corporation owes a 21% tax on the excess net passive income.10Office of the Law Revision Counsel. 26 USC 1375 – Tax Imposed When Passive Investment Income of Corporation Having Accumulated Earnings and Profits Exceeds 25 Percent of Gross Receipts
An S corporation that has always been an S corporation cannot generate earnings and profits, so this tax doesn’t apply. And if the corporation crosses the 25% threshold for three consecutive years, it loses its S election entirely and reverts to C status, which is often the bigger problem.
Basis, Distributions, and Suspended Losses
Your stock basis in the S corporation drives the tax on both losses and distributions. Basis starts with what you paid for your shares and adjusts each year: up for income allocated to you, down for losses, deductions, and distributions.11Internal Revenue Service. S Corporation Stock and Debt Basis
Two rules make basis worth tracking closely:
- Losses are capped at your combined stock basis and debt basis (money you personally loaned the corporation). Excess losses are suspended and carry forward. If you sell your stock before using them, they are permanently lost.11Internal Revenue Service. S Corporation Stock and Debt Basis
- A distribution that exceeds your stock basis is not a tax-free return of capital. The excess is taxed as a capital gain, long-term if you have held the stock more than a year.11Internal Revenue Service. S Corporation Stock and Debt Basis
Capital gains allocated to you through the K-1 raise your basis; distributions lower it. Keeping an accurate running number matters most in years with large asset sales, when pass-through gains and cash distributions can arrive together.
Selling the Business: Stock Sale vs. Asset Sale
When an owner exits, the transaction structure changes the rate you pay.
In a stock sale, you sell your shares directly. Your gain is sale price minus adjusted stock basis. The entire gain is typically capital gain, long-term if you held the shares more than a year. A stock sale also sidesteps the built-in gains tax at the corporate level, which matters for converted C corporations still inside the five-year window.
In an asset sale, the corporation sells its property and the gains flow through on K-1s. Not all of it qualifies as capital gain. Depreciation recapture on equipment and real property is ordinary income, and so are inventory sales. After the sale, the corporation distributes proceeds, triggering a second layer of analysis based on your basis and the accumulated adjustments account.
Sellers usually prefer stock sales for cleaner capital gains treatment. Buyers usually prefer asset sales for the stepped-up basis they can depreciate. That trade-off is one of the most consequential tax negotiations in any S corporation exit.