Paying Capital Gains Taxes on Stocks

Through stock market investments, it is possible to add several thousand dollars to your bottom line each year. As part of this wealth creation process, you are likely to be responsible for paying taxes on realized capital gains. Realized capital gains occur when you sell shares of stock at a profit. To calculate and pay taxes on realized capital gains, you must first identify the correct paperwork.

Identify Capital Gains Tax Paperwork

Again, you owe capital gains taxes on stocks when you sell shares at a profit. To calculate capital gains, you will need copies of the current tax years' IRS 1099 forms and brokerage statements. To report capital gains to the IRS, you will attach Schedule D to Form 1040. For tax purposes, capital gains are classified as either short or long-term capital gains. For the 2010 tax year, short-term capital gains are taxed at ordinary income rates of 10, 15, 25, 28, 33, and 35 percent. Long-term capital gains qualify for favorable tax treatment and are either tax-free or taxed at maximum 15 percent rates. For long-term capital gains, you must own a stock for more than one year before you sell it off at a profit.

Capital Gains Taxes on Stocks: Cost Basis and Sales Proceeds

As part of your realized capital gains calculation, you must also learn to determine cost basis and sales proceeds. Cost basis and sales proceeds effectively allow for deductible brokerage commissions. For example, you may trade stocks through an online brokerage at $10 per trade. In January, you bought 50 shares of Stock X at $100 per share. The cost basis of this transaction would then be $5,010 ($100 x 50 shares = $5,000 + $10 brokerage commissions = $5,010). Later that year, in October, you sell off your Stock X position at $125 per share. Your sales proceeds would then be $6,240 ($125 x 50 shares = $6,250 - $10 brokerage commissions = $6,240). At that point, you would owe taxes on $1,230 worth of short-term capital gains.

Realized Capital Losses on Stocks

For the 2010 tax year, you can deduct $3,000 in realized capital losses away from your taxable income. Losses that exceed $3,000 may be carried forward as tax-deductible items in future years. Be advised that the Internal Revenue Service prohibits wash sales -- for the sole purpose of taking a deductible loss. A wash sale occurs when you sell a stock at a loss and immediately buy the same stock back within the next 30 days.

Strategy

When trading stocks, your ultimate goal remains to make the most money for the least amount of risk. Making money in the stock market does not always translate into a minimal tax bill. For example, you should not hold onto a losing stock or trade excessively -- simply to generate tax write-offs. Investing for the sole purpose of a tax write-off will ultimately subtract value away from your bottom line, overall.

Paying Capital Gains Taxes on Stocks, Sources:

IRS: Capital Gains and Losses

IRS: 10 Facts About Capital Gains and Losses

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Buying Stocks: Dividend Reinvestment Plans (DRIPs)

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