6

If I want to sell some stocks to buy other stock do I have to pay taxes on the profits from the sale of the first stock?

How long can I keep the cash in my brokerage without having to pay taxes on it? (In other words do I only have so long to decide on which other stock to purchase?)

5

You realise a capital gain as soon as you sell the stock. At that point, you will have to pay taxes on the profits when you fill in your tax return. The fact that you used the money to subsequently purchase other stocks is not relevant, unless you sell those stocks within the same tax year.

For example, purchase $5000 of stock A in 2010. Sell for $6000 in 2010. Purchase $6000 of stock B in 2010. Sell stock B for $6500 in 2010. Purchase $6500 of stock C in 2010. Sell stock C for $7000 in 2011. You owe capital gains on ($6000 - $5000) + ($6500 - $6000) = $1500 for tax year 2010. You owe capital gains on ($7000 - $6500) = $500 for 2011.

  • 2
    Points off for not addressing the length the stock is held and how it affects the taxes that will be paid. This can have a HUGE affect on your tax burden. In your example, the 2010 taxes are made at the ordinary tax rate as they were held less than a year. Depending on when the buy and sale of stock C were made, the taxes could potentially be 'long term' and that would result in a lot lower tax rate (see blackjack's answer) – Chuck van der Linden Aug 5 '11 at 23:39
  • 1
    Good point. At the time I answered the question, it was not flagged 'United States'. In Canada, where I live, it appears that the length of time you hold your stock is irrelevant, though I am not an accountant. Nevertheless, I'm +1'ing Chuck van der Linden's comment because I expect most people reading this would be in the U.S. – ChrisInEdmonton Aug 6 '11 at 16:36
10

You can keep the cash in your account as long as you want, but you have to pay a tax on what's called capital gains. To quote from Wikipedia:

A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor.[1] Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price.

Thus, buying/selling stock counts as investment income which would be a capital gain/loss. When you are filing taxes, you have to report net capital gain/loss. So you don't pay taxes on an individual stock sale or purchase - you pay tax on the sum of all your transactions.

Note: You do not pay any tax if you have a net capital loss. Taxes are only on capital gains.

The amount you are taxed depends on your tax bracket and your holding period. A short term capital gain is gain on an investment held for less than one year. These gains are taxed at your ordinary income tax rate.

A long term capital gain is gain on an investment held for more than one year. These gains are taxed at a special rate: If your income tax rate is 10 or 15%, then long term gains are taxed at 0% i.e. no tax, otherwise the tax rate is 15%.

So you're not taxed on specific stock sales - you're taxed on your total gain. There is no tax for a capital loss, and investors sometimes take profits from good investments and take losses from bad investments to lower their total capital gain so they won't be taxed as much.

The tax rate is expected to change in 2013, but the current ratios could be extended. Until then, however, the rate is as is.

Of course, this all applies if you live in the United States. Other countries have different measures. Hope it helps!

Wikipedia has a great chart to refer to: http://en.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States.

5

@BlackJack does a good answer of addressing the gains and when you are taxed on them and at what kind of rate.

Money held in a brokerage account will usually be in a money-market fund, so you would own taxes on the interest it earned.

There is one important consideration that must be understood for capitol Losses. This is called the Wash Sale Rule. This rule comes into affect if you sell a stock at a LOSS, and buy shares of the same stock within 30 days (before or after) the sale.

A common tactic used to minimize taxes paid is to 'capture losses' when they occur, since these can be used to offset gains and lower your taxes. This is normally done by selling a stock in which you have a LOSS, and then either buying another similar stock, or waiting and buying back the stock you sold.

However, if you are intending to buy back the same stock, you must not 'trigger' the Wash Sale Rule or you are forbidden to take the loss.
Examples. Lets presume you own 1000 shares of a stock and it's trading 25% below where you bought it, and you want to capture the loss to use on your taxes.

  • If you sell all 1000 shares on 6/20 and buy them back on 7/22, then it's fine.
  • if you sell all 1000 shares and buy a different stock you are fine.
  • If you buy an additional 1000 shares on 6/20, and sell your original 1000 shares on 7/18 it's a wash sale and you cannot claim the loss.
  • If you sell all 1000 shares on 6/20 and buy them back on 7/18 it's a wash sale and you cannot claim the loss.
  • if you buy an additional 500 shares on 6/20 and sell all 1500 shares on 7/1 it's fine, you'd able to claim the loss on the original shares, and pay a gain or loss on the 500 additional (it's OK in this case because you sell ALL the shares).

This can be a very important consideration if trading index ETF's if you have a loss in something like a S&P500 ETF, you would likely incur a wash sale if you sold it and bought a different S&P500 ETF from another company since they are effectively the same thing. OTOH, if you sold an S&P500 ETF and bought something like a 'viper''total stock market' ETF it should be different enough to not trigger the wash sale rule.

If you are trying to minimize the taxes you pay on stocks, there are basically two rules to follow. 1) When a gain is involved, hold things at least a year before selling, if at all possible. 2) Capture losses when they occur and use to offset gains, but be sure not to trigger the wash sale rule when doing so.

  • +1 for wash sale. I've never met an investor who knew about wash sale before getting screwed by it! – BlackJack Aug 6 '11 at 0:29
  • I worked for a few years for a portfolio management company which specialized in tax efficiency as one of their ways of providing more return than the market average. One of the interview questions was how I would test if code that was checking on wash sale rule violations was working correctly. I got real familiar with that rule. right from day -4 – Chuck van der Linden Aug 6 '11 at 10:45

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.