Arizona Capital Gains Tax: Rates, 25% Subtraction, and 1031 Exchanges

The Arizona capital gains tax is the state’s 2.5% flat income tax applied to gains that pass through from your federal return, reduced by a 25% subtraction on qualifying long-term gains that drops the effective state rate to 1.875%. Short-term gains get no subtraction and pay the full 2.5%. Whatever you owe Arizona sits on top of federal capital gains tax, so your real cost is the two layers combined.

How Arizona Taxes Capital Gains

Arizona starts its income tax calculation from the federal adjusted gross income on your Form 1040. The legislature has adopted the federal Internal Revenue Code’s definitions of income, so the capital gains and losses you compute federally carry straight onto your Arizona return with no recalculation.¹

From that starting point, Arizona applies a single flat rate of 2.5% to all taxable income, regardless of amount or filing status. The flat rate took effect in tax year 2023, replacing a graduated structure that had topped out at 4.5%.² There is no separate capital gains schedule. Both short-term and long-term gains flow into Arizona gross income and face the same 2.5% rate before the long-term subtraction is applied.

The federal line between short-term and long-term gains therefore matters twice. Assets held one year or less are short-term and taxed federally at ordinary rates. Assets held more than one year are long-term, qualify for lower federal rates, and open the door to Arizona’s subtraction.³

The 25% Long-Term Subtraction

Arizona’s main break for investors is a subtraction equal to 25% of the net long-term capital gain included in your federal AGI. Only 75% of the qualifying gain gets taxed, which is what pulls the effective state rate from 2.5% down to 1.875%.⁴

There is a catch that trips people up. The subtraction only applies to assets acquired after December 31, 2011. Stock bought in 2005 and sold in 2026 produces a long-term gain, but no Arizona subtraction. For gifts and inherited property, the acquisition date traces back to when the original owner acquired the asset, not the date it was transferred to you.⁴

If you cannot document the acquisition date, the subtraction is disallowed entirely. Keep brokerage statements, purchase confirmations, and closing documents. Most disputes with the Arizona Department of Revenue on this subtraction land on proof of purchase date, not on whether the gain itself qualifies.

Federal Exclusions That Lower Your Arizona Bill

Because Arizona begins with federal AGI, anything that reduces your gain federally also reduces what Arizona can tax. Three provisions do most of the work.

Home Sale Exclusion

Sell your home after owning and living in it for at least two of the five years before the sale and you can exclude up to $250,000 of gain as a single filer, or $500,000 if married filing jointly.⁵ Excluded gain never enters federal AGI, so Arizona never sees it. No separate state claim is needed.

Stepped-Up Basis on Inherited Property

Inherited assets reset to fair market value at the date of death, erasing the tax on appreciation during the decedent’s lifetime. Arizona, as a community property state, strengthens this benefit: when one spouse dies, both halves of community property receive the stepped-up basis, not just the decedent’s half.⁶ A couple who bought stock for $100,000 that was worth $500,000 at the first spouse’s death leaves the survivor with a basis of $500,000. In a non-community-property state, the survivor’s basis would be $300,000.

Qualified Small Business Stock

Federal Section 1202 allows an exclusion of up to 100% of the gain on qualifying C corporation stock held more than five years, capped at the greater of $10 million or ten times your adjusted basis. The exclusion removes the gain from federal AGI, so Arizona conforms automatically. This is not a separate Arizona subtraction; it rides along with the federal starting point.

What You Actually Pay: Federal Plus Arizona

Your total capital gains cost is federal tax plus Arizona tax. Federal long-term rates are 0%, 15%, or 20%, with 28% on collectibles and 25% on the depreciation-recapture portion of real estate sales.³ Short-term gains are taxed federally at ordinary income rates, which can reach 37%.

Arizona then adds its layer. On a long-term gain from an asset acquired after 2011, that’s 1.875%. On a short-term gain, 2.5%. A single filer in the 15% federal long-term bracket selling a qualifying asset pays a combined rate of about 16.875%.

The 3.8% Net Investment Income Tax

Higher-income taxpayers also owe a 3.8% federal surtax on net investment income, including capital gains, once modified adjusted gross income passes $200,000 for single filers, $250,000 for joint filers, or $125,000 for married filing separately.⁷ These thresholds are not indexed to inflation. Arizona has no equivalent surtax, but a single large gain can push MAGI past the threshold and pull the 3.8% onto income that would otherwise have escaped it. With the surtax on top, combined rates for high earners can exceed 25%.

Who Owes Arizona on Which Gains

Residency determines what Arizona can tax. Arizona treats you as a resident if you are in the state for other than a temporary purpose, if you are domiciled here but away temporarily, or if you spend more than nine months of the tax year in the state (a rebuttable presumption).⁸

Full-year residents owe Arizona tax on all capital gains regardless of where the asset was located or sold. If another state also taxes the same gain, you can claim a credit on your Arizona return for income taxes paid to that state.
Nonresidents owe Arizona tax only on gains from Arizona sources, which generally means real property located in Arizona. Gains on stocks, bonds, and other intangibles usually are not Arizona-source income for nonresidents.
Part-year residents owe tax on all income earned during the Arizona-resident period plus any Arizona-source income earned during the nonresident period. Form 140PY allocates income between the two.

Deferring the Gain With a 1031 Exchange

A 1031 like-kind exchange lets you sell investment or business real property and reinvest the proceeds in similar property without recognizing the gain. The deferral applies at both the federal and Arizona levels because Arizona conforms to the IRC. Since the 2017 Tax Cuts and Jobs Act, 1031 is limited to real property; personal property, equipment, and collectibles no longer qualify.⁹

Two deadlines are strict. You have 45 days from the sale of the relinquished property to identify the replacement property in writing, and 180 days to close. Miss either and the entire gain becomes taxable in the year of the original sale.⁹ A properly executed exchange defers both the federal tax and Arizona’s 1.875% effective state rate.

Using Losses

If your capital losses exceed your gains in a year, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately). Unused losses carry forward. Because Arizona starts with federal AGI, the same net figure flows onto your state return.³

Watch the federal wash sale rule when harvesting losses. Selling a security at a loss and buying the same or substantially identical security within 30 days before or after disallows the loss; the disallowed amount gets added to the basis of the replacement shares. The rule applies across all your accounts, including IRAs and your spouse’s accounts.¹⁰ A disallowed federal loss is also disallowed in Arizona.

Claiming the Subtraction on Your Return

Full-year residents file Arizona Form 140, starting from federal AGI. The 25% long-term capital gains subtraction is claimed in the subtractions section; you identify the qualifying gain and calculate the subtraction on the appropriate line. Skip this step and you pay the full 2.5% instead of 1.875%. The Arizona Department of Revenue will not correct the omission for you.

Nonresidents use Form 140NR, which limits tax to Arizona-source income. Part-year residents file Form 140PY. All three forms begin from the same federal AGI and apply the same subtraction rules to qualifying long-term gains within the allocation that applies to that taxpayer.

Estimated Payments on a Large Gain

A big sale can create an estimated tax obligation at both levels. Arizona requires estimated payments if your Arizona gross income exceeds $75,000 ($150,000 on a joint return) and your prior-year income also exceeded those thresholds. Payments must total at least 90% of your current-year Arizona tax or 100% of your prior-year tax, whichever is smaller. Arizona waives the underpayment penalty if the tax due on your return is under $1,000.¹¹

Federally, you owe estimated taxes if you expect to owe $1,000 or more after withholding and credits. The safe harbor is 90% of your current-year tax or 100% of your prior-year tax, rising to 110% if your prior-year AGI exceeded $150,000.¹² Both federal and Arizona payments are due in four quarterly installments. Sell a highly appreciated asset mid-year without wage withholding to cover it and you can draw penalties at both levels.

1
Arizona Legislature. Arizona Code 43-102 – Declaration of Intent
2
Arizona Legislature. SB1828 – 551R – Senate Fact Sheet – Omnibus; Taxation
3
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
4
Arizona Legislature. Arizona Code 43-1022 – Subtractions From Arizona Gross Income
5
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
6
Office of the Law Revision Counsel. 26 USC 1014 – Basis of Property Acquired From a Decedent
7
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
8
Arizona Legislature. Arizona Code 43-104 – Definitions
9
Office of the Law Revision Counsel. 26 USC 1031 – Exchange of Real Property Held for Productive Use in a Trade or Business
10
Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
11
Arizona Legislature. Arizona Code 43-581 – Payment of Estimated Tax; Rules; Penalty; Forms
12
Internal Revenue Service. 2026 Form 1040-ES Estimated Tax for Individuals