Selling a stock for a profit creates a realized capital gain. These gains are taxable. How much in taxes an investor might pay is dependent on their income and the holding period of the asset. Some investors use this information for more tax-efficient stock investments. Let’s see how it works.
What Are Capital Gains?
Capital gains are profits from selling capital assets such as stocks, bonds, mutual funds, and real estate. Capital gains are taxable when they are realized. A realized gain happens when the asset is sold for a profit.
An unrealized gain occurs when the asset shows a gain but hasn’t been sold. Unrealized gains are not taxable.
For example, a stock is purchased for $60 and sold for $70. The investor has a $10 realized gain. This is the amount that will be taxed.
Short and Long-Term Gains
For tax purposes, gains come in two flavors — short and long-term. Assets that are held for a year or less incur short-term gains. Assets held for more than a year incur long-term gains. Using the above example, the investor purchased the stock in April and sold it in October of the same year. Because the entire transaction occurred within one year, it is a short-term gain.
Short-term gains are taxed at the investor’s regular income tax rate. Long-term gains have a tax benefit because they are taxed at a lower rate. For 2022, the long-term capital gains tax rates are 0%, 15%, and 20%. The rate is dependent on the investor’s income. The long-term gains tax rate won’t exceed 15% for most people.
How does taxation on capital gains work in a retirement account? Assets can be sold in a retirement account for a gain. However, because the account is tax-sheltered, the investor doesn’t incur any taxes on the sale, as long as the gain remains in the retirement account.
For a taxable account, such as a brokerage account, investors can offset taxable gains by using capital losses. A $2,000 loss on the sale of a stock can offset a $5,000 gain, creating a net gain of $3,000. Tax-loss harvesting involves intentionally selling capital assets at a loss to offset gains. Note that there is a $3,000 annual cap on the amount of loss that can be used.
Short-term and long-term losses and gains can be mixed. In other words, a short-term loss can offset a long-term gain.
Calculating capital gains on assets such as stocks, bonds, and options can be complex. That’s why working with an accountant is generally advised.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Examples shown are hypothetical and for illustrative purposes only.