Learn more about the tax treatment you may face with modern investment tools, and whether or not these tools support tax-efficient investing.
As technology grows and investing tools become more commonplace, there’s plenty to keep in mind to ensure you’re minimizing your tax liability. However, despite the availability of new tools and lower transaction costs, the amount you pay in taxes as a result of your investing decisions generally remains the same if these trades happen in an after-tax brokerage account.
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If you recognize a gain by selling stock on Robinhood or an exchange-traded fund on Betterment, or if you receive interest income from a bond index fund on Acorns, you’ll face tax consequences if these actions occurred in a non-tax-advantaged account.
To learn more about tax-efficient investing, let’s review some common tax rules when it comes to investments.
Capital gains taxes
When you invest, you pay money now for an asset that you hope will increase in value later. In the case of stocks, when it comes time to sell, if the sale price is greater than your cost, you’ll realize a capital gain. The type of capital gain will depend on the amount of time you held the stock before selling it.
You’ll want to become familiar with the tax implications of selling for a gain or loss. It’s also important to know why the holding period matters and how you can use tax-efficient investing strategies to get better results.
Short-term gains: If you buy an asset, hold it for one year or less, and sell it for more than you paid, you generally recognize a short-term capital gain. When this happens, Robinhood, Betterment, Stash, Acorns, or another investing platform may issue you a Form 1099-B during tax season highlighting your short-term capital gain. This gain is considered regular.Long-term gains: If you purchase shares of stock and sell them for a gain after holding them for more than a year, you generally recognize a long-term capital gain. In this situation, depending on your taxable income, you’ll usually be taxed at 0%, 15%, or 20%.
As an example of both, let’s assume you’re a single filer earning $100,000 of income and purchased $10,000 of a stock market index fund on June 1, 2019.
If you sold for $12,000 on March 31, 2021, you’d recognize a capital gain of $2,000 and pay short-term capital gains tax on this amount.If you sold the stock on July 1, 2021 (held the investment for over a year), you’d recognize the same $2,000 gain. But, this time it would be classified as a long-term capital gain and you’d pay long-term capital gains tax on this amount.
Unfortunately, not every investment will result in a gain. You might lose money on an investment by selling it for less than its cost, likely causing you to recognize a capital loss. In this event, you can often use these investment losses — but not losses from the sale of personal property — to offset capital gains.
For example, imagine that in one year you have:
$25,000 in long-term capital gains from one stock sale.$10,000 in long-term capital losses from the sale of another.In this instance, you’ll only recognize a long-term capital gain of $15,000 ($25,000 – $10,000).
If capital losses exceed capital gains, you can usually use up to $3,000 of the excess loss to offset other income for the year. Any unused amount carries forward to future years to offset future capital gains or income.
Note: One thing to be aware of when selling a stock at a loss is the wash sale rule. This disallows you from deducting capital losses when you buy replacement stocks or securities (including contracts or options) within a 30-day period either before or after you sold substantially identical securities.
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When you receive income from a stock or mutual fund, these payments are generally considered dividends. These “ordinary dividends” come in one of two forms: qualified and nonqualified.
Qualified dividends, such as those mostly paid on stocks, are generally taxed at long-term capital gains rates.Nonqualified dividends are taxed at the higher ordinary income tax rates.
Usually, qualified dividends are considered better from a tax perspective. To receive qualified dividend treatment, the IRS requires that you hold your stock investment for more than 60 days during the 121-day period that begins 60 days prior to the ex-dividend date — which is the day after a dividend-paying stock trades without rights to a declared dividend.
Taxable vs non-taxable account
The above tax implications occur in taxable accounts through brokerages such as Robinhood, Betterment, Stash, and Acorns. If you experience a taxable event during the year, you should receive tax forms at the beginning of the following year in time to complete your tax returns.
On the other hand, if you have these investments in tax-deferred or tax-free accounts, many of those taxable events won’t actually count.
If these were Roth accounts, you won’t pay any taxes on these events because gains and income in these accounts are non-taxable.In traditional tax-deferred accounts, an event such as a common stock paying a dividend is also not a taxable event.
By having fewer tax consequences in a tax-deferred or tax-free account, you can typically realize bigger gains and keep more of your money for when you need it in retirement.
Whether you have stock, bonds, ETFs, cryptocurrency, rental property income, or other investments, TurboTax Premier has you covered. Filers can easily import up to 10,000 stock transactions from hundreds of Financial Institutions and up to 4,000 crypto transactions from the top crypto exchanges. Increase your tax knowledge and understanding all while doing your taxes.