Stocks are considered capital assets, and as such they are taxed as capital gains if sold for a profit. The amount of tax owed by an individual investor from the sale of stock depends on a number of factors. This includes the purchase price of the shares, the gross selling price, fees incurred during the sale, the holding period, and the investor's taxable income from all sources during the tax year.
Capital Assets and Long-Term Capital Gains
Under the Internal Revenue Code, stocks, bonds, and other investment property are considered capital assets of the investor. To encourage investors to invest for the long term and not speculate, the Internal Revenue Code offers investors reduced tax rates on long-term capital gains generated from the sale of stock or any capital asset held for investment purposes. Long-term capital gains are gains on from the sale of capital assets held for more than a year. Capital assets held for a year or less are considered short-term capital assets. Gains from the sale of short-term capital assets are taxed at the investor's full ordinary income tax rates - the same rate at which salary and wages are taxed.
Long-Term Capital Gain Rates
Long-term capital gains are currently taxed at one of two rates. For those taxed at a marginal rate of 25 percent or less on ordinary income no tax is owed on long-term capital gains. For those in higher tax brackets, the long-term capital gain rate is 15 percent. Investors may only claim long-term capital gain rates after first offsetting any long-term capital losses and any net short-term capital losses against the aggregate amount of long-term capital gains.
Gains and losses from the sale of stock are not calculated until the stock is constructively sold. Prior to the sale of stock, gains and losses are considered to be unrealized gains. When the investor forgoes the economic risks and rewards of ownership - typically through a sale - the gain or loss is considered realized and is reportable as income. When calculating the gain or loss, subtract the cost basis of the stock, plus any fees incurred when selling the stock, from the gross proceeds received from the sale of the stock. An example of a basis other than the cost of the stock would be when the stock is inherited, in which case the basis would typically be the fair market value at the time of inheritance.
Gains or losses from the sale of stock are reported to the IRS on Schedule D to Form 1040, Capital Gains and Losses. Schedule D requires investors to segregate all sales between short-term and long-term capital gains. For each stock sold during the year, the investor must report a description of the asset sold, the date acquired, the date sold, the gross sales price of the stock, the basis of the stock, an the gain or loss of the stock. Taxpayers then use the Qualified Dividends and Capital Gain Tax Worksheet in the instructions to Form 1040 to calculate the tax due on any long-term capital gains.