As you start to diversify your financial portfolio, you'll likely look into investing. But do you pay taxes on investments? How much should you plan to account for? Our guide outlines some important points you need to know so you can invest with peace of mind.
Investing and taxes
Investing can be a great way to grow your assets, but what do you need to know when it comes time to file your taxes? Like most tax questions, the answer depends on your specific situation.
There are typically two times when your taxes are affected by your investments.
- The first is when you receive income from the investments.
- The second is when you sell the investments for a gain or loss.
Of course, there are possible exceptions and TurboTax can help you identify if any of these situations apply to you when you're completing your tax return.
Income from investments
Often, investment income includes interest and dividends. The income you receive from interest and unqualified dividends are generally taxed at your ordinary income tax rate. Certain dividends, on the other hand, can receive special tax treatment, which are usually taxed at lower long-term capital gains tax rates. Your investment brokerage company should provide information about whether your dividends are qualified or not.
Gains and losses from investment sales
You typically only have to pay taxes on the sale of investments when you receive a gain. To figure this out, you have to subtract the cost basis of your investment, which is normally what you paid, from the sale price to see if you had a gain or a loss.
- If you have a gain on the sale, you'll have to see if you owe taxes.
- If there's a loss, you may be able to offset other realized gains or take a deduction depending on your situation.
To qualify, you must first be selling a capital asset. Common examples of capital assets include:
- investments such as stocks or bonds
- your home
- other property
There are two general types of capital gains - short-term and long-term. Short-term capital gains are for capital assets you hold for a year or less. These gains are usually taxed at your ordinary income tax rate. Long-term capital gains are for capital assets you hold for more than a year. The long-term capital gains tax rates are typically lower than your ordinary income tax rate and generally max out at 20%.
Certain types of investments have higher capital gains tax rates. The most notable exception is collectibles, such as rare stamps, coins, art and more. These types of investments typically have a long-term capital gains tax rate of 28%.
In addition to the income taxes described above, those with significant income may be subject to the net investment income tax, which is an additional 3.8% tax on top of the usual capital gains taxes.
Thankfully, you can offset your capital gains with your capital losses if you have any. Like with capital gains, there are both long-term and short-term capital losses. Offsetting your capital gains with your capital losses can seem a bit overwhelming, but here's how it works.
- First you net your capital gains and capital losses of the same kind. That means subtracting short-term capital losses from short-term capital gains and long-term capital losses from long-term capital gains.
- If you end up having a short-term or long-term capital loss remaining, you can then reduce your short-term losses with your long-term gains or vice versa.
- If you still have more capital losses than capital gains in a year, most filing statuses can use up to $3,000 of any capital losses remaining to offset your ordinary income.
- Any excess capital losses above the $3,000 amount can be carried over to future tax years to offset future income according to the rules above.
As long as you continue using TurboTax each year to file your taxes, TurboTax can keep track of any carry-forward losses and apply them to your future tax returns.
Certain investments may have special tax treatment
Certain types of investments can have special tax treatment. For instance, municipal bonds are normally tax-free for federal income taxes but may be taxable on your state tax return, depending on the state you live in and the state that issued the bond you invested in.
- It's also possible to trigger special taxes, such as the alternative minimum tax (AMT) or the Net Investment Income Tax (NIIT). TurboTax can guide you through the process of figuring out if this applies to your situation or not.
- A big exception to the normal taxation of investments is money in tax-advantaged retirement accounts. Traditional retirement accounts, such as a traditional IRA or traditional 401(k), may allow you to take a tax deduction today for money that you invest. Then, the investments within the account can grow tax-free. When you withdraw the money in retirement after meeting the age requirements, the money typically counts as ordinary income and you will likely have to pay ordinary income taxes on this income.
- The other main type of tax-advantaged retirement accounts that are treated differently are Roth retirement accounts, such as a Roth IRA or Roth 401(k). You don't get a tax deduction for contributing to these accounts but the money can grow tax-free and you can withdraw it tax-free, including the investment gains, in retirement.
There may be other exceptions depending on your specific investments and circumstances as well. TurboTax can help you navigate these more complex areas.
Types of investments tax software can help with
With TurboTax software, figuring out what taxes you owe on your investments is straightforward. We’ll ask you simple questions about your investments, you can easily import your information, and we’ll search over 400 tax deductions to make sure you get every credit and deduction you qualify for.
With TurboTax, figuring out what taxes you owe on your investments is straightforward. Here are some of the most common types of investments TurboTax can help with:
- Bonds including municipal bonds
- Mutual funds
- Exchange-traded funds (ETFs)
- Restricted stock units (RSUs)
- Stock options
- Real estate investment trusts (REITs)
- Rental real estate
- Sale of a home
- Investments within a retirement account
- Collectibles including rare stamps, coins, art and more
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