Tax planning and compliance for investors
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Answers for people who are new to capital gains and losses.
We all start with zero knowledge and go on from there. Here are some basic questions people sometimes ask about capital gains, along with my answers.
Q: My stocks went up but I didn't sell yet. How much gain should I report?
A: None! As a general rule you don't report capital gain or loss until you sell. There are exceptions, such as when you receive capital gain distributions from a mutual fund.
Q: I bought stock for $1,000 and sold for $1,200. My gain was only $200 but my broker reported $1,200 to the IRS. Help!
A: Brokers don't report the amount of gain. They report the amount you received on the sale. It's up to you to report the sale properly on your return, indicating the correct amount of gain or loss.
Q: Does a capital gain increase my income?
A: There's a vague notion out there that capital gains aren't income because they're taxed at their own special rates. Folks are hoping, perhaps, that capital gains won't count when they determine whether they can deduct an IRA contribution, or how much of their social security benefit is taxable, or how much of their exemptions are phased out, among other things. Unfortunately, capital gains are income. A special calculation provides the lower capital gains rate, but doesn't remove capital gains from your overall income (or adjusted gross income).
Q: Does a capital loss reduce my income?
A: As a general rule, you can deduct capital losses up to the full amount of your capital gain plus $3,000. If your capital losses exceed your capital gains by more than $3,000, the excess is carried forward to the next year.
Q: I'm in the 15% bracket. Why do I have to pay 28% on some of my capital gain?
A: You don't. If you have a 28% capital gain, you pay your regular rate or 28%, whichever is lower. The same is true for a 25% gain.
Q: I'm concerned that a capital gain will push my other income into a higher tax bracket. Doesn't this mean the real cost of a capital gain is higher than it appears?
A: No, capital gain is "stacked" on top of your other income, so it won't push the other income up into a higher tax bracket. As we pointed out earlier, a capital gain increases your income, and that could cause you to lose a benefit somewhere. For example, your exemptions or itemized deductions might be reduced when you have a capital gain. So there can be some indirect tax costs when you have a capital gain. But your other income stays in the same bracket when you have a capital gain.
Q: My mutual fund reported that I sold shares even though I didn't take any money out! Why?
A: If you move money from one fund to another within the same family of funds, you're selling one fund and buying the other. If the first fund went up before you made the move, you have to report a gain and pay tax on it. Consider the tax consequences before moving money to a different fund, even within the same family of funds!
Q: I had capital gains in my IRA. How much tax is owed, and who has to pay it?
A: Until you take the money out, the answer is no tax. But when this money comes out of your IRA, you'll have to report it as ordinary income — not capital gain. Of course, if you have a Roth IRA and meet all requirements you'll pay no tax at all.
Q: I have some stocks that went up, and I'm ready to sell. I want to transfer them to my son and have him sell them because he's in a lower tax bracket. Does this work?
A: Not if you're planning on getting the money back from your son. If you make a legitimate gift, and don't get anything back, then the gain will be taxed on your son's return. Even then, the tax might not apply at a lower rate because of the "kiddie tax." And you need to be aware of potential gift tax consequences, too.
Q: I have some stocks that went down, and I'm not ready to sell because I think it's going back up. Can I sell it for the loss and then buy it back right away?
A: You won't be able to deduct the loss if you buy back right away, because of the Wash Sale Rule. You need to wait at least 31 days before buying the same stock again if you want to claim a loss.
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