Kentucky does not tax capital gains at a special rate. A gain from stocks, a business or real estate is part of your federal adjusted gross income, and Kentucky taxes income at one flat rate. The rate fell from 4% to 3.5% for 2026, a change that not every Kentucky page reflects yet: when we read the Department of Revenue's Individual Income Tax web page it still said four percent, while the 2026 withholding formula and the legislature's record of HB 1 say 3.5%.
This guide uses the Kentucky General Assembly's record of 2025 HB 1, the Department of Revenue's 2026 withholding formula and standard deduction announcements, its 2025 Form 740 and Form 740-NP instruction packets and two IRS pages, all read on 3 November 2026. We did not read the Kentucky Revised Statutes themselves, so every rule below is stated as the Department states it.
The General Assembly's record of 2025 House Bill 1 summarizes the enacted version as reducing the individual income tax rate from four percent to 3.5 percent for taxable years beginning on or after January 1, 2026, and shows it signed by the Governor on 6 February 2025 (Acts Chapter 1). The Department of Revenue's 2026 Kentucky withholding tax formula agrees: the 2026 Kentucky tax rate is 3.5% of taxable income, applied as a flat rate after a 2026 standard deduction of $3,360.
For the previous year, the Department's 2025 Form 740 packet says the tax rate for individual income tax is 4% and the standard deduction is $3,270. One caution: the Department's Individual Income Tax web page still said the tax rate is four percent when we read it. That matches the 2025 return, not 2026, so for a 2026 sale rely on HB 1 and the withholding formula, and check the Department before filing.
Next year: the Department announced that the 2027 standard deduction is $3,470, an increase of $110 (announcement). We found no enacted rate for 2027 in the pages we read, so check before planning a sale for a later year.
The Form 740 instructions for line 5 say to enter the total amount of your federal adjusted gross income from your federal income tax return, and not to confuse it with federal taxable income. A capital gain reported on your federal return is therefore already in your starting figure, and Kentucky taxes it with the rest of your income. We read nothing in the Kentucky packets that treats short-term and long-term gains differently.
Kentucky then adjusts that figure on Schedule M, Modifications to Federal Adjusted Gross Income. The packet's federal-versus-Kentucky comparison chart lists two gains it treats as taxable federally and exempt in Kentucky: capital gains on the sale of Kentucky turnpike bonds, and capital gains on property taken by eminent domain (the latter also appears in the list of other subtractions). On the addition side, the packet tells filers to add back the portion of a lump-sum distribution on which they elected the 20 percent capital gains rate for federal purposes (Schedule P and Form 4972-K). We found no general capital gains subtraction in the packet's additions and subtractions lists. The packet also says Kentucky income tax law is based on the federal law in effect on December 31, 2024.
There is also a basis rule. The packet lists differences in gains (losses) from the sale of depreciable property placed in service after September 10, 2001 as an adjustment, and says to compute Kentucky gain or loss from the disposed assets using the Kentucky basis and report the difference. This matters mainly to business owners and landlords who used special depreciation or increased Section 179 expensing.
The federal system can tax a net capital gain at a lower rate than ordinary income. IRS Topic 409 says that if you have a net capital gain, a lower tax rate may apply than the rate that applies to your ordinary income, that you generally have a long-term gain if you hold the asset for more than one year, and that net short-term capital gains are taxed as ordinary income at graduated rates. Kentucky's return, as the Department describes it, applies one flat rate to taxable income. We found no holding-period or lower-rate rule in the Kentucky packets.
This table is our arithmetic (gain times the flat rate), not an official calculation. It shows the Kentucky tax a gain adds when it sits on top of your other taxable income, ignoring credits, exemptions and adjustments, rounded to the nearest dollar.
| Capital gain included in federal AGI | Added Kentucky tax at 3.5% (2026) | Added Kentucky tax at 4% (2025) |
|---|---|---|
| $10,000 | $350 | $400 |
| $50,000 | $1,750 | $2,000 |
| $100,000 | $3,500 | $4,000 |
| $500,000 | $17,500 | $20,000 |
Worked example (ours): a single filer has $60,000 of wages and a $50,000 long-term gain in 2026, takes the $3,360 standard deduction and has no adjustments, credits or dependents. Federal adjusted gross income is $110,000 and Kentucky taxable income is $106,640, so tax at 3.5% is $3,732. Without the gain, taxable income would be $56,640 and tax $1,982. The gain adds $1,750. Real returns can differ because of credits, itemized deductions and other items on Form 740.
The Kentucky packets we read do not set out a separate capital loss limit. Because the return starts from federal adjusted gross income, we read the effect as carrying the federal result into Kentucky; the Department does not say this in so many words. IRS Topic 409 says that if your capital losses exceed your capital gains, the excess you can claim to lower your income is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss, and that a larger net capital loss can be carried forward to later years. For property where Kentucky basis differs from federal basis (see above), the packet says to compute the Kentucky gain or loss on the Kentucky basis and report the difference.
The Department says Individual Income Tax is due on all income earned by Kentucky residents and all income earned by nonresidents from Kentucky sources. Full-year residents file Form 740. Full-year nonresidents with Kentucky-source income and part-year residents use Form 740-NP.
On gains specifically, the Form 740-NP instructions say gains (losses) on sales of assets, including installment sales, while a Kentucky resident must be reported on the Kentucky return, and that gains (losses) on sales of tangible assets located in Kentucky must be reported regardless of state of residence. They add that, generally, gains (losses) on sales of intangible assets are reported to the state of residence. That is the Department's general statement, so ask the Department if your case is unusual, such as an interest in a Kentucky business.
Moving mid-year: people moving into Kentucky report income from Kentucky sources before becoming residents and income from all sources after becoming Kentucky residents; residents moving out report income from all sources while a resident and from Kentucky sources while a nonresident. The packet also treats someone not domiciled in Kentucky who lives in Kentucky for more than 183 days during the tax year as a resident who must use Form 740-NP.
The Kentucky instructions start from federal adjusted gross income, and we found no separate Kentucky home sale rule. IRS Topic 701 says you may qualify to exclude up to $250,000 of the gain on the sale of your main home from your income, or up to $500,000 if you file a joint return with your spouse. Because that excluded gain is not part of your income on the federal return, we read the effect as leaving only the gain above the exclusion for Kentucky to tax at the flat rate; the Department's pages we read do not say this in so many words. For the federal test, see our home sale capital gains guide.
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