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 capital gains tax by reinvesting your profits in other companies.
Tax Consequences of Reinvesting
If you buy stock for $1,000 and it earn money, it's not until you sell the stock that you are subject to taxes. 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. 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.
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.
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 and you realize capital gains, 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. So you're definitely better off if you keep the investment for more than a year, because the tax you pay will be lower. 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.
Exceptions, or Avoid Capital Gains Tax by Reinvesting
Stock capital gains are like capital gains tax on real estate. 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. So, back to our example where you bought $1,000 of stock. By the end of the year, the value has climbed to $1,500, but you still own the stock. You don't have to report a $500 gain on your taxes, just like the home sale capital gains exclusion.
This is also true if your stocks are in retirement accounts, like 401Ks. Then your stock gains are reinvested, hopefully earning you more money. You can also rebalance by putting your money into underperforming investments.
Paying Taxes for 2018
If you're compiling information for your 2018 tax return, the long term investment capital gains rates are taxed at three levels, zero, 15 and 20 percent. For a married couple filing jointly, you'll pay zero if your adjusted gross income is less than $72,220. You'll pay 15 percent if your income is $72,221 to $479,000. Couples above that income pay 20 percent. Short-term tax gains, as they have been in previous years, are taxed as regular income. To access the latest IRS forms for investment income, go here.
Paying Taxes for 2017
If you're doing your 2017 tax return, the tax rate for long-term capital gains investments is zero percent for income up to $75,000 for couples filing jointly, 15 percent for those in the $75,000 to $225,000 income range, and 20 percent for couples who earn over $225,000.
If you have long-term investments, and you're in the 10 to 15 percent tax brackets, you may not owe tax on capital gains from securities and mutual fund shares. Also, any investment losses you may have may lower your capital gains taxes. Capital losses on investment can offset capital gains and up to $3,000 of your regular income.
- IRS: Topic 409 -- Capital Gains and Losses
- IRS: Publication 550 -- Investment Income and Expenses
- Fidelity Investments: What Does Reinvesting Capital Gains Mean?
- Vanguard: Capital Gains Distributions Demystified
- Nerdwallet: 2018 Capital Gains Taxes and How to Avoid Paying a Big Tax Bill
- Motley Fool: Long Term Capital Gains Tax Rates in 2017
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- Selling a Stock After Purchase
- The Definition of Realized Gain and Loss
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