Taxes on Investments: What Investors Need to Know

Investing is a powerful way to grow your wealth, but it also comes with tax implications that every taxpayer should understand. Whether you invest in stocks, bonds, mutual funds, or other assets, your earnings may be subject to investment taxes. In this taxes and investments guide, we’ll break down how taxes on investments work to help you understand how selling investments may impact your federal tax bill.

At a glance:

Investments are taxed differently based on type — stocks, real estate, and ETFs all have their own tax treatments.
Capital gains tax depends on how long you hold an investment.
Dividends and interest income are also taxable.
Tax-loss harvesting and tax-advantaged accounts can help lower your investment tax bill.

Understanding investment taxes

Before diving into the specifics, it’s important to understand what counts as investment income and how the IRS taxes different types of earnings.

Some common sources of investment income are:

Capital gains: Profits from selling an investment at a higher price than you paid for it.
Dividends: Payments from companies or funds to shareholders.
Interest income: Earnings from bonds, savings accounts, or other interest-bearing investments.
Distributions: Payments from mutual funds, ETFs, or other pooled investment vehicles.

Each type of investment is taxed differently, and your filing status and income level will determine how much you owe. We’ll cover how some of these are taxed below.

Tax rules: How are investments taxed?

Stocks & ETFs: Gains are taxed as capital gains, dividends are taxed at either ordinary or qualified rates (more on this later).
Cryptocurrency: The IRS treats crypto as property, meaning capital gains tax applies when you sell, trade, or spend it for a profit.
Stock options: Typically taxed as ordinary income upon exercise (purchase), and any subsequent gains are subject to capital gains tax.
Mutual funds: May have capital gains distributions taxed at capital gains rates.
Real estate and real estate investment trusts (REITs): Selling real estate at a profit is subject to capital gains tax, but you may defer taxes using a 1031 exchange. REIT dividends may be taxed as ordinary income or qualify for special tax treatment.
Municipal bonds: Interest is tax-exempt at the federal level (and possibly at the state level).
Annuities: Growth is tax-deferred, but withdrawals are taxed as ordinary income.
Retirement accounts: Tax treatment depends on the type of account (IRA, Roth IRA, 401(k), etc.). Traditional accounts offer tax-deferred growth, meaning contributions are pre-tax, and withdrawals are taxed as ordinary income. Roth accounts, on the other hand, are funded with after-tax dollars, but qualified withdrawals are tax-free.

Capital gains tax explained

What is capital gains tax?

When you sell an investment for a profit, you generate a capital gain, which is subject to income tax. To complicate matters a bit, the capital gains tax rate you pay depends on how long you hold the investment before selling.

To help you report your capital gains on your tax return, your brokerage will typically send you Form 1099-B. This tax form details your capital gains, cost basis, and any adjustments needed for tax reporting.

What is cost basis?

Understanding your cost basis is crucial when calculating capital gains and other investment taxes. Cost basis refers to the original price you paid for an investment, including any associated fees or commissions. When you sell an investment, your capital gain or loss is determined by subtracting the cost basis from the sale price. Learn more about how to calculate cost basis.

Short-term vs. long-term capital gains tax

Short-term capital gains tax applies to investments held for one year or less. These gains are taxed as ordinary income, which means they are subject to your regular income tax rate as determined by your tax bracket.
Long-term capital gains tax applies to investments held for more than one year. These gains benefit from lower tax rates: 0%, 15%, or 20%, depending on your taxable income and filing status.

Long-term capital gains tax rates for 2024

Here are the long-term capital gains tax rates for the 2024 tax year based on your filing status:

Tax Rate	Single	Married Filing Jointly	Married Filing Separately	Head of Household
0%	$0 to $47,025	$0 to $94,050	$0 to $47,025	$0 to $63,000
15%	$47,026 to $518,900	$94,051 to $583,750	$47,026 to $291,850	$63,001 to $551,350
20%	$518,901 or more	$583,751 or more	$291,851 or more	$551,351 or more

How to calculate capital gains tax on stocks

To calculate capital gains tax on stocks you’ve sold, use this formula:

Sale price – Purchase price (cost basis) = Capital gain

If you sell a stock or other capital asset for less than what you paid for it, you’re left with a capital loss, which can offset your capital gains and lower your tax bill. The difference between your capital gains and losses is called your net capital gain or net capital loss.

Capital gains tax calculator: How to estimate capital gains taxes

Estimating your capital gains tax can help you plan ahead for tax season. To get an idea of what you might owe, consider:

Your cost basis (the original purchase price of your investment).
The sale price of your investment.
How long you held the investment (short-term vs. long-term capital gains tax rates).
Your income level and filing status, which determine the applicable tax rate.

For an easy way to estimate your capital gains tax liability, use TaxAct’s capital gains tax calculator.

Capital losses and how they can offset gains

What are capital losses?

A capital loss occurs when you sell an investment for less than its cost basis. Investors can strategically use capital losses to offset capital gains and lower their taxable income. This is called tax-loss harvesting.

However, it’s important to be aware of wash sale rules when selling investments for this purpose.

IRS wash sale rules

The IRS enforces wash sale rules, which prevent investors from claiming a capital loss on a security if they repurchase the same or a “substantially identical” security within 30 days before or after the sale. This rule is designed to prevent investors from selling investments just to claim a tax benefit while quickly buying them back.

To avoid a wash sale violation, consider:

Waiting at least 31 days before repurchasing the same security.
Buying a similar but not “substantially identical” security. If you’re unsure whether a security might be considered substantially identical, it may be wise to consult a financial advisor or tax professional.
Selling one investment and purchasing a different type of asset with similar exposure.

Maximum deduction limits

If your capital losses exceed your capital gains, the IRS allows you to deduct up to $3,000 per year (or $1,500 if married filing separately) from your ordinary income. If your total capital losses exceed this amount, you can carry over the remaining losses to future years.

Carrying over losses

If your net capital loss exceeds the allowed $3,000 deduction, the excess loss can be carried forward indefinitely to offset gains in future years. Basically, each year, you can continue deducting up to $3,000 until the loss is fully used. This carry-forward strategy can be beneficial if you anticipate high capital gains in the future.

Taxes on dividends and interest income

Now that we understand capital gains taxes let’s examine how dividends and interest income are taxed.

Dividend taxes: qualified vs. ordinary

If you own shares of stock or index funds, companies may periodically pay you in dividends. Dividends are often considered taxable income and must be reported on your federal tax return.

There are two types of dividends:

Ordinary dividends (nonqualified dividends): Like short-term capital gains, ordinary dividends are taxed as ordinary income at your standard income tax rate. You might receive nonqualified dividends as distributions from corporations or mutual funds.
Qualified dividends: These are taxed at the lower long-term capital gains tax rates of 0%, 15%, or 20%. Like long-term capital gains, your filing status and income determine your tax rate. The IRS has specific rules for qualified dividends, including holding periods, which can be found in IRS Publication 550 (page 28).

Your brokerage should provide a 1099-DIV form detailing your dividend earnings during the tax year.

Interest income and how it’s taxed

Interest income from savings accounts, CDs, corporate bonds, and annuities is taxed as ordinary income.
Municipal bonds generate tax-exempt interest at the federal level (and sometimes at the state level).
Taxable interest is reported on Form 1099-INT.

Exchange-traded funds (ETFs)

Due to their unique structure, exchange-traded funds (ETFs) are generally more tax-efficient than mutual funds. Unlike mutual funds, which must distribute capital gains to shareholders when portfolio managers buy and sell holdings, ETFs use a special creation and redemption process that allows you to redeem ETFs without triggering a taxable event.

Here’s how the process works:

When an investor buys ETF shares, an authorized participant (AP) creates new ETF shares by exchanging a basket of underlying stocks for ETF shares, rather than selling individual stocks.
When an investor sells ETF shares, the AP redeems them for the underlying stocks rather than selling the assets for cash.

Because ETFs avoid selling securities directly to meet redemption requests, they minimize capital gains distributions to shareholders. This process helps ETFs be more tax-efficient than traditional mutual funds, which may be required to sell securities, triggering capital gains distributions for shareholders.

If you’re ever unsure about how selling a particular investment will affect your taxes, don’t be afraid to ask a professional for advice!

Net investment income tax (NIIT)

If you’re a high earner, you may face an additional 3.8% NIIT on investment income if your modified adjusted gross income (MAGI) exceeds:

$200,000 (single filers)
$250,000 (married filing jointly)
$125,000 (married filing separately)

The additional tax applies to capital gains, dividends, interest, and passive rental income. It applies to either your total net investment income or your net investment income that exceeds the MAGI thresholds above (whichever is less).

Check out the IRS NIIT FAQ page for more info on this topic.

Investment strategies to reduce your tax bill

How to avoid capital gains tax (legally!)

While you can’t always eliminate capital gains tax, you can take steps to reduce your tax liability:

Hold investments for over a year to qualify for lower long-term capital gains rates.
Time your sales to fall in years with lower income, reducing your taxable gain.
Gift or donate appreciated assets to avoid taxes.

Tax-loss harvesting

Remember, you can use capital losses to offset capital gains if you sell investments at a loss. If your losses exceed your gains, you can deduct up to $3,000 against ordinary income ($1,500 if married filing separately) and carry forward any excess losses to future years.

Tax-advantaged accounts

Investing through certain retirement accounts, education savings accounts, or health savings accounts can shield earnings from immediate taxation:

Traditional IRA & 401(k): Contributions may be tax-deductible, but withdrawals are taxed as ordinary income.
Roth IRA: Contributions are made with after-tax dollars, but qualified withdrawals are tax-free.
529 Plans: Earnings grow tax-free when used for education expenses.
Health Savings Account (HSA): Offers tax-free contributions, growth, and withdrawals for medical expenses.

State investment taxes

Some states impose their own state taxes on capital gains, while others do not tax investment income at all. Always check your state’s tax laws to understand your potential liabilities when selling investments.

Eight states currently do NOT tax capital gains:

Alaska
Florida
Nevada
New Hampshire (still taxes certain investment income such as interest and dividends)
South Dakota
Tennessee
Texas
Wyoming

FAQs about investment taxes

What are the tax implications of selling stock?

Stocks and other capital assets must be reported on your tax return, and you may have to pay taxes on interest earned, dividends, or capital gains from selling the stocks.

Does selling stock count as income?

The sale of stock for a profit results in a capital gain. Capital gains are typically included in your taxable income but can be taxed lower than ordinary income tax rates. Stocks sold for a loss are not taxed, but you can use your losses to offset your gains.

Do I have to pay taxes on stocks I don’t sell?

No, you won’t owe taxes on capital gains if you didn’t sell any of your investments during the tax year. However, you may still owe taxes on any dividends and interest you earned.

How can I lower my tax liability on investments?

If you want to avoid taxes or pay the least amount of tax when selling your investments, here are some suggestions to keep in mind:

Timing: If practical, hold the asset longer than one year before selling to take advantage of long-term capital gain tax rates.
Tax-loss harvesting: Don’t be afraid to sell some stocks at a loss to help offset your capital gains.
Reduce income in other ways: Consider other ways you might be able to lower your taxable income, such as making contributions to a tax-advantaged retirement account, investing in your business, or taking other tax-saving measures.

Tax Tip: Sometimes, robo-advisors may offer free tax-loss harvesting services.

What are the long-term capital gains tax rates?

Long-term capital gains are taxed at 0%, 15%, or 20%, depending on your taxable income and filing status.

How can I prepare for paying taxes on stocks?

After tax filing, consider the amount of tax you owed on your investments this year, if any. As you continue to invest and your money grows, your taxes will likely continue to increase. To avoid paying even more taxes, you may also want to consider a tax-advantaged investment account, such as a 401(k), Roth IRA, traditional IRA, or HSA.

How to report investment income on your tax return

To accurately report your investment earnings, you’ll need the following tax forms:

1099-B: Reports capital gains or losses from selling investments.
1099-DIV: Reports dividend income.
1099-INT: Reports interest income.
Schedule D: Summarizes your capital gains and losses.
Form 8949: Reports sales and exchanges of capital assets, detailing cost basis and adjustments.

Not to worry — TaxAct® can walk you through all these forms and simplify your tax filing process.

The bottom line

Understanding investment taxes is crucial for making informed financial decisions. By knowing how capital gains, dividends, and interest income are taxed, you can take advantage of tax-saving strategies to help maximize your returns. Plus, using TaxAct makes it easy to report and pay the right amount of tax on your investments while staying compliant with IRS rules.

Remember, a little planning goes a long way when it comes to investment taxes. Knowing the ins and outs will help you keep more of your investment earnings in your pocket (and maybe reduce your tax burden while you’re at it!).