First Time Investors, Here’s What You Need To Know About Taxes

More people than ever are investing in stocks, especially Millennials and Gen Z. While investing for your future as well as retirement is important, it’s just as important to understand the tax implications, which can often catch investors off guard.

Here are some helpful tips to guide you as you begin your journey as an investor.

Keep good records

Although modern-day brokerages and investment apps have transaction records, they’re not always perfect. 

It’s always good to have a backup transaction log of what you’ve purchased, including the purchase date, number of shares, cost basis, as well as a record that includes commission and other fees. If there are mergers and acquisitions or other similar company events, keep track of those details as well.

Taxes are assessed on realized gains

For many new investors, it’s not always clear how investments are taxed. 

Unrealized gains aren’t taxed until you sell

If you buy a stock and the value of it goes up, you don’t have to pay taxes on those gains every year. You only pay taxes when you sell the investment and “realize” the gain (meaning you’re selling the investment for a higher price than what you paid).

For example, if you buy 10 shares of Company X for $10 and the stock grows to $12, you don’t owe taxes on the $2 unrealized gain, yet. Your investment will continue to grow, year after year, without being taxed. However, when you sell the stock, only then will the gain be reported on your tax return as a capital gain.

The same rules apply to losses

While investments go up in value, they can also go down. When you have an investment that decreases in value, there aren’t any tax implications until you sell your investment. 

For example, if you buy 10 shares of Company Y for $10 but the stock value later decreases to $8, you have an unrealized loss of $2 per share, but you haven’t incurred a realized loss. You only realize the loss when you actually sell that stock. You would then have a capital loss reported on your tax return for the year of sale.

Realized losses offset realized gains

Realized losses can be used to offset realized gains. In the above scenario, with Company X increasing by $2 and Company Y decreasing  $2, you have a realized gain of $20, and a realized loss of $20, respectively. If those transactions occurred in the same tax year, the gain is offset by the loss, and you will owe nothing in taxes since the overall capital gain or loss nets out to zero.

Long term vs. short term capital gains

When it comes to your gains, it’s good to know the difference between short-term and long-term capital gains.

Short-term capital gains tax rate applies when you sell an investment after holding it for one year or less. Long-term capital gains tax rates apply when you sell an investment after holding it for more than a year.

The short-term capital gains tax rate is the same as your income tax bracket. For example, if you’re in the 22% income tax bracket, then any short-term capital gains incurred from a sale during the year are also taxed at 22%.

Long-term gains get a better deal. They’re taxed at either 0%, 15%, or 20%, depending on your taxable income and filing status. 

Capital losses can offset income

If you had a rough year in the market, there’s a small silver lining. 

If your capital losses are greater than your capital gains in a year, you can use up to $3,000 of those capital losses to reduce your ordinary income, resulting in a lower taxable income amount. Any capital loss remaining after using that $3,000 is carried forward to future tax years indefinitely until it is completely used up.

Net investment income tax

One more thing to be aware of is the net investment tax. You may be subject to the net investment tax of 3.8% if you’re filing as single or head of household when your modified adjusted income is over $200,000, over $250,000 for those filing as married filing jointly, or over $125,000 for those filing as married filing separately.

This extra tax of 3.8% is imposed on the lessor of your net investment income or on the excess amount where your modified adjusted gross income exceeds the threshold amounts.

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Recommended reading

If you’re looking to sell your stocks, don’t miss “I Sold Stocks This Year. Do I Pay Tax on the Whole Sale?”

You might be surprised by the answer.