When Are Capital Gains Realized?

When you sell a stock at a higher price than you paid for it, a profit is generated. In most cases, that profit is taxed. Specifically, if the profit is a realized gain, it is taxed. But when exactly does a profit become a realized gain?

Investment Transactions

To generate a profit, a sell at a higher price needs to be paired with a buy in the same instrument. For example, you buy 100 shares of Microsoft stock at $300 and sell it at $310. That’s a $10 profit. The total profit or gain is 100 x $10 = $1,000. In this case, a buy was paired with a sell to generate a profit. 

The buy and sell is an investment transaction. It’s similar to buying groceries. In order to receive groceries, a buy and sale must occur. You go to the store and can buy only what is for sale. 

In the investment world, the first part of the transaction doesn’t have to be a buy. Stocks can be shorted, which means the transaction starts with a sale instead of a buy. But for simplicity, we’ll stick to buying stocks or going long stocks.

We mentioned “gain” earlier. A gain is synonymous with profit. But gain is often used within the context of taxes. 

So, is our gain in the above example a realized gain? If we are investing in a regular brokerage account and not a retirement account, then yes. Unlike a retirement account, a brokerage account doesn’t have a tax shield. By selling the shares at a profit, we create a taxable event. 

The profit doesn’t even need to come out of the brokerage account. The broker will send a tax document to you with all of your investment activities. It is your responsibility to report profits or losses from trading activities to the IRS.

If you do have a loss, it can be offset by gains. This means that gains will be reduced by the number of losses (up to $3,000) and thus potentially reduce your tax bill.

In addition to the account type determining taxation (i.e., retirement vs. non-retirement), the time that an investment is held also determines the tax rate on gains.

Short and Long-Term Gains

Investments are taxed at capital gains rates. There are two capital gains rates — short and long-term.

Investments that are held for less than a year are taxed at the short-term gains rate. This rate is your ordinary income tax rate. Investors who hold for a year or more get the long-term gains rate. Long-term gains are taxed at a lower rate compared to short-term gains. The rate will vary by your income level.

For 2022, long-term capital gains rates are: 

While long-term rates are more favorable, depending on the investment and the investor’s financial situation, holding an investment for a year or more may not be practical.

Realized Gains on the Sale of a Home

Realized gains work differently for home sales. Figuring out the realized gain on a home sale can be more complex than that of stocks. The average cost basis must be calculated. Then applicable expenses are deducted during the sales process to find the realized gain.

There are a few advantages that home sellers have which aren’t available to stock investors. One is the sale of a primary residence. Subject to certain rules, the first $250,000 in profit on the sale of a home is not taxable for those filing single. The amount goes up to $500,000 for those who are married filing jointly.

Real investors can also take advantage of a 1031 exchange. A 1031 exchange defers taxes owed on gains by doing a like-kind exchange.

As situations are unique to each person and can be very complex, it’s best to work with your tax advisor when determining realized gains.