Basic Tax Treatment of a Brokerage Account

Having an investment account is wonderful until you’re hit with a tax bill – expected or unexpected. Here’s a quick refresher on how taxable investments are taxed by the Internal Revenue Service (IRS).

Capital Gains

In short, capital gains taxes may occur when you sell (or dispose of) an asset.

For example, say an investor purchased 1 share of XYZ Corporation for $25 per share. As time passes, say the stock is now worth $40 per share. At this point, the investor decides to sell their stake in XYZ Corporation, cashing in on his or her gains. The difference between the stock’s purchase price (otherwise known as the stock’s basis), $25 per share, and the sale price, $40 per share, is a net capital gain of $15.

As indicated by the above example, capital gains (or appreciation) avoid taxation until the gain is “realized.” In other words, the IRS will not tax you on capital gains until the asset is sold.

Investment assets held for less than one (1) year are called short-term capital gains. Investment assets held for more than one (1) year are called long-term capital gains.

Note: IRS tax rates applied to long-term capital gains are often lower than those applied to short-term capital gains. Short-term capital gains are taxed at the taxpayer’s ordinary income tax rate, whereas long-term capital gains qualify for preferential tax treatment.

Dividends and Interest

Dividends and interest are broad terms used to describe distributions from various savings and investments. Most common distributions include: 

·       Qualified dividends, paid from company earnings and are taxable at the reduced long-term capital gains rates.

·       Interest paid from taxable bond investments is taxed at ordinary income tax rates.

·       Interest paid from municipal bond investments is generally tax-free.

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