Do You Know How Your Investments are Taxed?

Investors generally pay close attention to portfolio allocation, performance, strategy and even fees.  The impact of taxes, however, is often overlooked when evaluating an investment portfolio.

This blog post will highlight various ways that investors are taxed, including the capital gains tax, capital gain distributions, net investment income tax, and what the difference is between qualified and non-qualified dividends.

There are a few quiz questions along the way so pay attention!

Capital Gains and Losses

When you sell an asset for more than you paid to acquire it (i.e. your cost basis), the government shares in your appreciation. An asset can be a stock, bond, or fund – but also a house, a collectible, a gold bar, home furnishings, etc.  Because there are some nuances when selling other assets, this post will focus only on the sale of securities.

If you owned a security for less than one year prior to selling it, any gain in that security’s value (the difference between your purchase price and its sale price) is taxable to you as ordinary income.

However, if your holding period is greater than one year, the investment gains are taxed at long-term capital gains rates.  Because the government wants to incentivize long-term investment (rather than “churning” portfolios, with high turnover), these rates are more favorable than ordinary income taxes.

Below are the 2018 federal capital gains tax rates for the three income brackets:

These rules also apply to securities sold below their cost basis – a holding period of less than one year is considered a short-term loss, and longer than one year is a long-term loss.  Your holding period is relevant because at the end of each year you net your short-term and your long-term transactions together. If both holding periods result in gains (or both in losses), they are reported separately on Schedule D.  However, if one holding period results in a gain and the other in loss, then they are netted against each other.

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