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How-to: Taxes for your Stock Trades

Mar 16, 2008
There are a few things you should be aware of when it comes to taxes for your investments. Note that many of these tips are specific to 2007 tax returns in the United States.

Taxed on Sells, Not Buys
The first thing to realize is that you are charged tax on the profits of your trades, which means the IRS does not care about your trade until you sell the shares.

Tax Forms from your Brokerage
Your brokerage should send you a 1099 tax form in January that lists all of your sales and dividends from the previous year. Two examples are "Form 1099-B Proceeds from Broker & Barter Exchange Transactions" and "Form 1099-DIV Dividends and Distributions." These forms will be needed to complete your tax return. Note that these forms may or may not include the purchase information for those trades. You are required to get that information from your brokerage records to fill out your tax return so the IRS will know how much profit you you made.

Short-Term vs. Long-Term Trades
If you kept your shares more than a year, they are considered "long-term capital gains" and you are rewarded with a lower tax rate of 15% in most cases. Otherwise, if you held the shares for less than a year the profits will be taxed the same as your regular wages. These are called "short-term capital gains."

Dividends and Interest
Many public companies distribute dividends or other forms of cash and shares to their shareholders when they have extra profits. You will be taxed on them of course. These are usually reported to you on the 1099-DIV form.

Wash Sales
What in the world is a wash sale? This IRS rule was created to try to reduce cheating on investment taxes. Let's say you buy 100 shares of Microsoft at $25 per share, then it drops to $20. You decide to sell it for a loss and then buy it right back at $20, hoping to get a tax deduction on the "loss" you just suffered. Well the IRS doesn't like this practice and they consider it a wash sale if you buy very similar stock within a month (before or after) of your sale for a loss. You aren't penalized for this wash sale, you just have to apply the loss to a future trade. Please read more about wash sales on the IRS website.

Listing All Sales
The tax forms usually ask for a detailed list of all stocks you sold in the previous year, including the company name, number of shares, gross proceeds, and the cost basis. The cost basis is used to determine how much profit you made when you sold the shares. It is the total amount you spent when you purchased the shares, including the commission. The "gross proceeds" is the total amount you received back when you sold the shares, after the commission and SEC fees were deducted.

However, if you bought and sold many stocks during the year it might be too time-consuming to enter in each one individually. An alternative is to combine all the sales into one line and call the company name "Various" and just add up all the numbers. This is a common practice. The IRS doesn't really care which shares you traded, just the total profit you made during the year. In any case, it can be a real time-saver to keep accurate records of all of your trades, perhaps in a spreadsheet.

Other Topics
This article is not a comprehensive list of all aspects of investment taxes, so please do more research if you have any questions. One special topic is "short-selling." If you did any short selling there are some special rules involved. Another topic is "professional traders," who get taxed differently. They can count some investment expenses as tax deductions, for example. The best thing to do is consult with a tax professional, especially if this is your first time to do taxes with investments.
About the Author
Nicholas Swezey is the creator of the Stock Market Simulation at HowTheMarketWorks.com.
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