If you're an investor, it's likely that at some point you've had both winning and losing investments. Knowing about the tax consequences of selling stocks for both gains and losses in taxable brokerage accounts is an important part of making smart investment choices.
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What Are the Tax Consequences of Gains From Your Investments?
When you sell an investment for a profit, the amount earned is likely to be taxable. The amount that you pay in taxes is based on the capital gains tax rate. Typically, you'll either pay short-term or long-term capital gains tax rates depending on your holding period for the investment. Short-term rates are the same as for ordinary income such as the tax on wages.
- For 2021, these rates range from 10% to 37% depending on taxable income.
- Long-term gains are typically taxed at 0%, 10%, or 20% also depending on your taxable income.
What Are the Tax Consequences of Losses From Your Investments?
If you sell an investment for less than your cost, you have a capital loss. You can possibly use that capital loss to reduce your capital gains in the same year. If you have more losses than gains, you may be able to use up to $3,000 of the excess loss to offset ordinary income on your taxes in the same year. After using $3,000 of the excess loss to offset other income, the rest can be carried forward to the following year to offset gains and other income again.
What Are Short-term and Long-term Capital Gains and Losses?
Short-term and long-term capital gains are typically taxed at different rates. Short-term capital gains are gains on investments you've held for less than one year. These gains are taxed at a rate equal to the rate you're taxed on your ordinary income such as wages and taxable interest income. These rates range from 10% to 37% in 2021 and depend on your taxable income.
Long-term capital gains are gains you have on investments you've held for longer than one year, and they're usually taxed at a lower rate than short-term gains and other ordinary income. The long-term capital gains rates for 2021 are 0%, 15%, or 20% and, like short term rates, depend on your taxable income.
Are There Restrictions on Deducting Investment Losses From my Taxable Income?
Typically, you can use losses to offset gains. You must first match short-term losses to short-term gains and long-term losses to long-term gains. After this, the net long-term gain or loss is matched against the net short-term gain or loss. Once you've used all of your losses to reduce your gains, up to $3,000 of the loss can be used to offset other ordinary income in the tax year. Any additional leftover loss can be carried forward to the following year.
Investors often choose to take a capital loss on investments in order to offset a capital gain during the same tax year. This is known as “tax-loss harvesting.” If you want to take a loss from a losing investment, you need to be aware of the “wash sale” rule. This rule doesn’t allow you to take the loss if you (or your spouse) buy the same or substantially the same investment within 30 days before or after the sale of the investment.
The opposite of “tax-loss harvesting” is “gain harvesting.” This is when investors sell an investment at a gain and then immediately buy it back. When done on a routine basis – perhaps just over a year – the gain can be small enough that it's taxed a low long-term capital gains rate – perhaps 0% - rather than selling it after several years when the gains may be taxed at a higher rate of 10% or 20%. Unlike with short-term losses, there is not a wash sale rule for gains.
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What if an Investment Became Worthless?
You can't take a deduction on an investment until the year the investment becomes worthless, so you'll have to show that the stock had value at the beginning of the year but not at the end of the year. Likewise, if you bought stock in a company that went bankrupt, you won't be able to deduct anything until the bankruptcy is discharged and you know whether you can collect anything.
If you believe that the stock won't ever pay off, but you can't prove it's worthless, you may sell it on the open market for a few pennies or a dollar to nail down your deduction. If you can't sell the security, you can abandon it by giving up all rights in the security and not receiving anything in return.
If you learn your investment became worthless in a prior year, you can file an amended tax return for that year to possibly claim a refund. Though you usually have a time limit of three years to file an amended return, in the case of worthless investments, you have up to seven years from the date your original return was due to claim a deduction.
How do I Report Short-term and Long-term Capital Gains From the Sale of Stocks?
You report capital gains and losses on Schedule D of your tax return. If the cost basis of any investments that you sold were not reported to the IRS or if you need to make any adjustments to the transactions reported to you on form 1099-B or 1099-S, then you should also file Form 8949.
- The information from Form 8949 is used to completed Schedule D.
- The amounts from Schedule D are then transferred to 2020 version of Form 1040, Line 13 of your income tax return.
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Should Taxes on Stock or Stock Market Performance Influence my Buying and Selling?
You can see from the above information that there are strategies that can influence when to sell certain investments whether they're at a gain or a loss. Understanding how certain losses and gains affect your taxes the way they do is important in making good investments decisions.
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