Capital gains | Taxes | Achievable SIE

A capital gain is realized when a customer sells a security at a higher price than its original cost. If you’ve heard anyone say, “buy low, sell high,” they’re talking about capital gains. Otherwise, selling a security below its cost is a capital loss. A gain or loss is realized upon a position being closed out (long securities sold or short securities bought back). Investors compare their cost basis to sales proceeds to determine the overall gain or loss.

Cost basis represents the overall amount paid to buy the security, including any commission. Sales proceeds represents the overall amount received to sell a security, minus commission. In basic terms, cost basis represents the overall amount paid for an investment, while sales proceeds represent the overall amount received for selling it. To better understand this concept, let’s work through an example:

An investor purchases shares of ABC stock at $50 while paying a $2 per share commission. Several months later, the stock is sold for $70 while paying another $2 per share commission. What is the cost basis, sales proceeds, and capital gain or loss?

Can you figure it out?

(spoiler)

Cost basis = $52

The cost basis is equal to the cost of the investment ($50) plus commission ($2), which represents the overall amount paid to purchase the investment.

Sales proceeds = $68

Sales proceeds are equal to the sale price of the investment ($70) minus commission ($2), which represents the overall amount received to sell the investment.

The capital gain or loss = $16 capital gain

Subtracting cost basis from the sales proceeds ($68 - $52) determines the overall gain or loss. If it’s a positive number, it’s a capital gain. If it’s a negative number, it’s a capital loss.

Capital gains can be long or short-term. Long-term capital gains are made on securities held for longer than a year. Technically, an investor needs to hold an investment for one year and a day in order to be long-term. Long term capital gains are taxed in the same manner as qualified dividends.- 0%, 15%, or 20% depending on their annual income level.

Sidenote

Vague test questions

You may encounter a test question regarding long-term capital gain tax rates that does not specify the specific tax rate or indicate the investor’s annual income level. You should assume a 15% rate on long-term capital gains if this occurs.

Bottom line - assume a 15% tax rate on qualified dividends or long-term capital gains unless the question indicates otherwise.

Short-term capital gains are made on securities held for one year or less. Short-term capital gains are taxed at the investor’s income tax bracket, which could be as high as 37% (similar to non-qualified dividends). Obviously, investors prefer long-term capital gains because they’re taxed at lower rates. As a reminder, these are the income tax brackets for individuals and those filing jointly in 2024:

Rate	Individuals	Married filing jointly
10%	$0	$0
12%	$11,601	$23,201
22%	$47,151	$94,301
24%	$100,526	$201,051
32%	$191,951	$383,901
35%	$243,726	$487,451
37%	$609,351	$731,201

Do not memorize these tax brackets; this chart is only for context.

Definitions

Marginal tax bracket: The tax bracket applied to the last dollar earned

Example: an individual making $50,000 would pay a 10% tax on the first $11,600 earned, a 12% tax on additional income up to $47,150, and a 22% tax on the remaining income received. Although the investor is taxed at three different rates, they fall in the 22% tax bracket.

Capital gains are reported on form 1099-B (B stands for brokerage proceeds). Every year, brokerage firms report their customers’ capital gains and losses to the IRS. If the investor has more gains than losses (net capital gain), they will owe taxes. A net capital loss can be used as a deduction.

Sidenote

Inherited securities

Death is an unfortunate aspect of life, but the IRS attempts to make the grieving process easier by reducing tax burdens on inherited securities. In particular, two tax-beneficial things occur:

Cost basis is “stepped up”
The holding period is automatically long-term

When an investor dies, their assets are passed on to their beneficiaries. The new cost basis of the security reflects the value on the day of the original owner’s death. Also, the holding period for the inheritor is long-term, regardless of how long the original owner held the investment.

Key points

Capital gain

Securities sold for more than the basis
Reported on tax form 1099-B

Long-term capital gain

Gain on security held more than 1 year
Tax rate: 0%, 15%, or 20%

Short-term capital gain

Gain on security held for 1 year or less
Tax rate: up to 37%

Inherited securities

Cost basis is stepped up to the value on the date of death
Holding period is always long term