Learn about basic capital gains tax on investment rules and tax-loss harvesting strategies to help maximize after-tax returns and potentially reduce the amount you owe.
Taxes are a part of investing, and the way you build and manage your portfolio can potentially impact how much you owe. Here are some basic investment tax rules and strategies that may help you possibly reduce your tax bill.
Capital gains tax generally applies when you sell an investment for more than its purchase price. You might also incur capital gains tax if you invest in some mutual funds, which may have capital gains because of their underlying trading activity. The tax rate varies based on how long the security was held before it was sold. If it’s held for more than a year, it’s considered a long-term gain and the tax rate could reach 20%, depending on your income level. For most investors, the rate is likely to be 15%.
If an investment is sold within the first 12 months, it’s considered a short-term gain, which generally receives less favorable treatment. The gain is counted as ordinary income, and the tax rate may be as high as the marginal income tax rate, 37%. Many investors may face short-term rates between 22% and 32%.
Given the difference in investment taxation between the long term versus the short term, it’s common for investors to hold securities for at least a year before selling if market conditions and investor goals make that possible. It could have a meaningful impact on your after-tax returns. In this way, investors facing the highest income tax rate could potentially reduce it from 37% to 20%, cutting their tax burden almost in half, if again market conditions and investor goals don’t require closing the trade earlier.
Of course, there may be times when you have a capital loss because an investment is sold for less than its purchase price. These losses are generally deductible, which may help reduce your taxable income. But there’s a limit: Net capital losses may only offset up to $3,000 of ordinary income per year.
Dividends are also usually subject to taxation. Here, the IRS also uses different rates depending on the classification. “Qualified dividends” are true dividends according to the IRS, while “non-qualified” dividends include insurance premium rebates, credit union distributions, dividends from foreign investments, and co-op “dividends”. Almost all equity security distributions are considered qualified as long as the security is held for more than 61 days, but double-check before you file. Most likely, you’ll receive a 1099-DIV from your broker or other investment provider that shows the breakdown between qualified and non-qualified dividends. And remember, even automatically reinvested dividends may be taxable.
Qualified dividend tax rates may range from 15% to 20% for most investors. For high income earners, this rate can be meaningfully less than the tax rate on ordinary income.
Dividends and capital gains might be something to consider when comparing mutual funds. Investors wishing to mitigate the tax burden of owning a mutual fund may look for funds that meet their needs and also historically haven’t traded actively and thus made significant capital gains.
Keep in mind, the past history of a mutual fund does not guarantee that the same policies or behaviors will continue, but it does give you at least an idea of how that investment has been managed in the recent past. Of course, for those investors looking for mutual funds that hold “blue-chip” stocks or more income-oriented stocks, dividend taxes may be unavoidable.
Also with tax implications worth considering are exchange-traded funds (ETFs). The tax implications on ETFs can be complicated and vary depending on the asset class and structure, but in general, an ETF investment isn’t taxed at the investor level until you sell it.
If you’re a full-time trader as defined by the IRS, you may be eligible for certain tax deductions that could help reduce the amount you owe.
Given the complexity of the tax rules for full-time traders, you might want to work with a tax advisor who can help you make more informed decisions based on your unique situation.
For investors and part-time traders, another tax minimization strategy might be tax-loss harvesting. With this strategy, an investor or financial professional, such as a TD Ameritrade Investment Management Portfolios Specialist, identifies a currently held security that has an unrealized loss. This security is sold, the loss is netted against other realized gains in the current tax year, and a similar but not substantially identical security is purchased. The tax loss is thus realized and “harvested” for the current year, while the portfolio retains similar securities.
To help satisfy IRS rules, the security that’s purchased must be different from the one sold. This requirement may be most easily met with ETFs or mutual funds. For example, selling a small-cap value ETF or mutual fund from one investment provider and purchasing a different one from another provider could meet this requirement.
Maintaining a tax-efficient investment portfolio may help you move forward. Don’t want to build your own? Consider a managed portfolio solution* from TD Ameritrade Investment Management, LLC.
The key to filing taxes is being prepared. TD Ameritrade provides information and resources to help you navigate tax season.
Quick Links
Trade
Invest
Service
Do Not Sell or Share My Personal Information
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Carefully consider the investment objectives, risks, charges and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.
ETFs can entail risks similar to direct stock ownership, including market, sector, or industry risks. Some ETFs may involve international risk, currency risk, commodity risk, leverage risk, credit risk and interest rate risk. Trading prices may not reflect the net asset value of the underlying securities. Commission fees typically apply.
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
*Advisory services are provided by TD Ameritrade Investment Management, LLC, a registered investment advisor. Brokerage services provided by TD Ameritrade, Inc. TD Ameritrade Investment Management provides discretionary advisory services for a fee. Risks applicable to any portfolio are those associated with its underlying securities. For more information, please see the Disclosure Brochure (ADV Part 2).
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2023 Charles Schwab & Co. Inc. All rights reserved.