The Tax Consequences of Reinvesting Stock Capital Gains

You won't avoid capital gains taxes by reinvesting.

You won't avoid capital gains taxes by reinvesting.

Watching the prices of the stocks in your portfolio go through the roof can be exciting. When you think the prices have maxed out, you might want to move the money to other stocks that you think have more potential for growth. Unfortunately for you, you can't avoid taxes on capital gains by reinvesting your profits in other companies.

Triggering Capital Gains Tax

When you invest in capital assets, such as stocks or real estate, you don't pay taxes on the gains until you realize them -- typically when you sell the asset. For example, say you buy $1,000 of stock and by the end of the year it's climbed to $1,500, but you still own the stock. You don't have to report a $500 gain on your taxes. However, if you sell the stock for $1,600 in the next tax year, you report the entire $600 gain on your taxes for that year.

Paying Taxes on Gains

Once you've sold your stocks, the Internal Revenue Service expects to see that income reported on your taxes that year regardless of how you spend the money. You can't delay paying taxes on the gain by buying more shares of a different company. For example, say you sell $1,600 of Company A, giving you a $600 gain, and turn around and by $1,600 of Company B. You have to pay taxes on $600 of capital gains, but your basis for the Company B stock is $1,600.

Dividend Reinvestment Plans

This rule also applies to dividend reinvestment plans, because dividends are generally treated as capital gain income. Some companies offer plans in which any dividends you earn are automatically used to purchase additional shares of the company. For example, instead of receiving $100, you would automatically receive two shares if the stock is worth $50. Even though you never saw the money in cash form, the IRS still expects you to report $100 of capital gain income on your taxes.

Resetting the Clock

How long you own an investment can make a big difference when it comes to your tax rate on your capital gains. If you hold an investment for a year or less, you pay taxes on it at your ordinary income tax rates. But if you hold the investment for more than one year, you get to pay the lower long-term rates. The holding period for investments resets each time you buy and sell a stock. For example, say you bought stock for $1,000 in January, sold it for $1,500 and reinvested it in other stock in July and then sold that stock for $2,000 the following February. You must report $500 of short-term capital gains in both years because you didn't hold either investment for more than one year.

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