How Investment Income Is Taxed
Investment income can reach your return in several ways: interest, dividends, fund distributions, or a gain when you sell. The tax treatment depends on what you received, the account holding the investment, and your records.
Start with the account and income type
This overview focuses on taxable accounts. Earnings inside traditional retirement accounts generally grow tax-deferred, while qualified Roth distributions can be tax-free. Selling an investment inside an IRA generally does not create the same current capital gain as selling it in a taxable brokerage account.
| Income in a taxable account | Usual federal treatment |
|---|---|
| Bank interest and nonqualified dividends | Ordinary income tax rates generally apply. |
| Qualified dividends | Generally eligible for 0%, 15%, or 20% rates. Issuer, holding-period, and other requirements apply. |
| Net short-term capital gain | Ordinary income tax rates generally apply when an investment was held one year or less. |
| Net long-term capital gain | Generally eligible for 0%, 15%, or 20% rates when held more than one year. Total taxable income and filing status determine the rate. |
Taxable dividends must be reported even if you reinvest them. Mutual funds can also distribute taxable capital gains even when you have not sold shares. Review the categories on Form 1099-DIV rather than treating every payment alike.
Bond exemptions depend on the tax involved. Treasury interest is federally taxable but exempt from state and local income taxes. Certain municipal-bond interest is federally exempt; state treatment requires a separate check. See the IRS interest guidance.
Keep track of basis before selling
Basis is the amount used to measure your gain or loss. Purchased shares generally start with their cost, including purchase fees. Reinvestments create additional shares with their own basis; return-of-capital distributions generally reduce basis and can produce a gain after basis reaches zero.
Different purchase lots, gifted or inherited investments, and corporate changes need separate attention. Keep supporting records even when a broker reports basis. The IRS basis guide explains these rules.
For example, assume shares have a $10,000 adjusted basis and the proceeds below are after selling expenses:
| Calculation | Sale at a gain | Sale at a loss |
|---|---|---|
| Net proceeds | $15,000 | $8,000 |
| Adjusted basis | $10,000 | $10,000 |
| Gain or loss | $5,000 gain | $2,000 loss |
Special assets have different rules: long-term collectibles gains can face a maximum 28% rate, and certain gains attributable to real-estate depreciation a maximum 25% rate. These are maximum rates, not automatic flat rates.
Use losses with the limits in mind
Capital losses first offset capital gains. Remaining net losses can generally reduce other income by up to $3,000 a year, or $1,500 if married filing separately. Unused losses carry forward and may offset future gains and the allowable annual deduction. Losses on personal-use property are not deductible.
A wash sale can disallow a stock or securities loss if you buy substantially identical securities within 30 days before or after selling. Automatic reinvestments and purchases through another account, a spouse, or an IRA can matter. The loss is often deferred through replacement-share basis, but an IRA purchase can make it permanent. Check the IRS investment-income rules before buying back.
Check the additional investment-income tax
The 3.8% net investment income tax applies to the smaller of net investment income or modified adjusted gross income above $250,000 for joint filers and qualifying surviving spouses, $125,000 for married filing separately, or $200,000 for single and head-of-household filers.
Tax-exempt interest and distributions from qualified retirement plans and IRAs generally are excluded from net investment income. Taxable retirement withdrawals can nevertheless increase modified adjusted gross income and expose other investment income to this tax. The IRS overview explains the calculation.
Review the records and payment timing
Keep tax statements, purchase records, and prior capital-loss carryovers. Most investment sales go through Form 8949 and Schedule D. Interest and dividends may also need to be reported on Schedule B. Report taxable income even if no tax form arrives. A large distribution or sale may also require estimated payments or additional withholding before you file.