Tax on Investments: Capital Gains Tax & Tax-Loss Harvesting

Your investment decisions could impact your tax bill. Learn about the basic rules and some strategies to help maximize after-tax returns and potentially reduce the amount you owe.

Print
https://tickertapecdn.tdameritrade.com/assets/images/pages/md/
3 min read

Key Takeaways

  • Full-time traders may be eligible for certain tax deductions
  • Capital gains taxes generally apply when an investment is sold for more than its purchase price
  • Tax-loss harvesting is a strategy used by some investors to potentially lower tax liability

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 and Losses

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- vs. 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, again, if 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 $3000 of ordinary income per year. 

Dividends

Dividends are also usually subject to taxation. Here, too, the IRS 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. 

Full-Time Trader Deductions

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.   

  • Trading expenses. You may be able to deduct costs for IT equipment, research subscriptions, and other direct trading expenses, like data feeds, educational tools, and charting software.
  • Trading losses. If you meet the IRS criteria, you may be able to make a “mark to market” election and treat any open positions with unrealized losses as “closed” on the last day of the calendar year for tax purposes, deducting the loss against your income. This could potentially be a huge tax savings if you have both earned income and unrealized capital losses. However, this election is often difficult to file, and it’s one the IRS examines closely.

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.

Tax-Loss Harvesting

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. 

Call Us
800-454-9272

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 Investment Management, LLC (“TD Ameritrade Investment Management”) and its affiliates do not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances as to whether the TD Ameritrade Investment Management tax-loss harvesting feature is appropriate for you. This feature generally would be more beneficial to investors in higher tax brackets and high-tax states.

The tax-loss harvesting feature is currently only available with the TD Ameritrade Investment Management ETF-based portfolios in taxable TD Ameritrade Investing Accounts. Tax-loss harvesting is not appropriate for all investors. Investing in securities involves risk of loss that the client should be prepared to bear. TD Ameritrade Investment Management does not represent or guarantee that the objectives of the tax-loss harvesting feature will be met. The performance of the replacement securities purchased through the TD Ameritrade Investment Management tax-loss harvesting feature may be better or worse than the performance of the securities that are sold for tax-loss harvesting purposes. TD Ameritrade Investment Management only reviews each account that is managed by it individually to help ensure that your account does not violate the “wash sale” rule. When you enroll in the tax-loss harvesting feature, the enrollment is on an account basis and does not apply to other TD Ameritrade Investment Management portfolios you may have. Each eligible TD Ameritrade Investment Management portfolio must be enrolled separately in the TLH feature. Accordingly, you are responsible for monitoring your brokerage accounts and your spouse’s brokerage accounts at TD Ameritrade or elsewhere to ensure that transactions in the same security or a substantially similar security do not create a wash sale. The wash sale rule postpones losses on a sale, if replacement shares are bought around the same time.

Prior to enrolling in the tax-loss harvesting feature, please read TD Ameritrade Investment Management’s whitepaper and see the TD Ameritrade Investment Management Disclosure Brochure (Form ADV Part 2A).

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).

adChoicesAdChoices

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.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. 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.

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. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2018 TD Ameritrade.

Scroll to Top