Investing can help you build wealth for short and long-term goals.
But the money you earn on your investments in a personal brokerage account can be subject to taxes once you sell your holdings, or close your account. That’s why it’s important to understand the tax consequences of selling your investments. Read on to find out more.
Understanding brokerage account selling
Any time you invest in the stock market, your investment has the potential to increase in value. For example, a stock you may purchase for $20 at some point could be worth $60 later on. That increase in value, or profit, once realized is called a capital gain. That profit is “realized” when you sell it. And that profit can be subject to different types of taxes, based on how long you’ve held the stock you plan to sell.
(If you lose money, which is always a risk when investing, it’s called a capital loss. Generally speaking you won’t owe taxes on a security that has decreased in value from the time you bought it.)
Short-term capital gains vs. Long-term capital gains
There are both short-term and long-term capital gains, and each one is taxed differently:
- Short-term capital gains are for investments held one year or less.
- Long-term capital gains are for those held for more than one year.
Short-term capital gains are essentially taxed at the same rate as your ordinary income for federal income tax purposes, and that rate can be nearly twice as high as the rate for long-term capital gains. The top ordinary income rate, for example, is currently 37%. The top long-term capital gain rate is 20%.
- Good to know: There are seven ordinary income tax brackets ranging from 10% to 37%.
- There are only three long-term capital gain brackets: 0%, 15%, and 20%.
In other words, it can pay to hold your investments for longer periods of time, as you may pay less in taxes.
Paying taxes on dividends
A dividend is a portion of a company’s earnings, paid out to shareholders of some investments.1 Some people reinvest their dividends automatically with a dividend reinvestment plan or DRIP, which you can set up with your Stash account if you have one. Whether you reinvest your dividends or not, you’ll likely have to pay taxes on dividend earnings.
The rate at which the dividends are taxed depends on whether they are ordinary (nonqualified) or qualified dividends. An ordinary dividend is taxed at the same rate as your income is taxed. So if your income is taxed at 24%, dividends you earn are also taxed at that rate.
By contrast, you may pay the lower long-term capital gain rate on a qualified dividend. Generally speaking, a qualified dividend must meet certain criteria in order to be characterized as such. It must be issued by a U.S. company or qualifying foreign company. It is also for a stock that you’ve held for a period of 60 out of 121 days, usually within a specified window of time counted from something called the ex-dividend date. (You can find out more about qualified dividends and ex-dividend dates here.)
Follow the Stash Way
Stash encourages you to follow the Stash Way, our investing philosophy which includes investing regularly, and investing for the long run.