Stocks are hot these days and in some respects, the market is doing better than it’s ever done. Additionally, investing is easier than ever with the explosion of retail trading apps. But many people are hesitant to begin investing until they know how it’s going to impact their taxes. Here are the tax basics of investing in stocks.
Realized And Unrealized
If you open a standard brokerage account with any of the popular companies, you then deposit money and invest that money. You typically invest in a number of different stocks or funds, often referred to as “diversification”. A few months go by, and all of your investments are up a bit.
You now have “unrealized” gains. Once you sell those investments or any part of them that has appreciated, you then have “realized” your gains. This is the same for losses. If your investments are down and you then sell them to stop your losses, you have turned your “paper” losses into “realized” capital losses.
Capital Gains
Once you invest through your brokerage of choice, and you have invested in a number of stocks. One of your stocks shoots to the moon, and you suddenly find yourself selling those stocks for a healthy sum. You now have realized your capital gains, and you will now have to eventually pay taxes on them. They’ll be listed on your upcoming 1099-B form that your brokerage will provide at the end of the tax season.
There is more, and it might be good news, it might be bad news, depending on your particular investments and gains. You’ve now got capital gains, and you need to pay taxes, but the tax rate is going to depend on how long you held that investment.
Investments that are sold less than a year after purchase are classified as short-term capital gains. These can be taxed up to 35%. However, if you keep your investments for a minimum of a year before selling, you can cut that down to 15% or less.
Capital Losses
It happened. Your investment tanked, and you lost big time. If you are still on paper, your losses are unrealized, but if you sold to stop the bleeding, then you can leverage those realized capital losses. Your capital losses can be claimed against your capital gains, to offset them and pay a lower tax rate. Additionally, if your losses cancel out your gains, you can claim up to $3k in additional losses against your income.
Dividends And Interest
Not only will you be taxed on capital gains, but you will also be taxed on dividends. These are periodic payments made to shareholders of certain stocks by the company they are invested in. You are taxed on dividends even if you do not sell any investments. The interest you can be taxed on is interest from bonds and will vary depending on the type of bond and interest that has been earned.