How is capital gain income taxed differently than ordinary income?

Capital gains income is taxed differently than ordinary income primarily due to the holding period of the asset. When an individual sells a capital asset, such as stocks or real estate, the profit made from that sale is classified as a capital gain. The tax treatment of this gain depends on how long the asset was held before it was sold.

Short-term capital gains, which apply to assets held for one year or less, are taxed at ordinary income tax rates, which can be significantly higher. In contrast, long-term capital gains, for assets held longer than a year, are taxed at reduced rates, which range from 0% to 20% based on the taxpayer's income level. This favorable treatment encourages investment and long-term holding of assets.

The option stating that capital gains are taxed at lower rates, depending on how long the asset was held, accurately reflects this distinction in taxation. It highlights the tax benefits associated with long-term investing, contrasting sharply with the taxation of ordinary income, which does not benefit from these preferential rates.