When are investments taxed?

Question

I opened a brokerage account at Fidelity earlier this year to do some personal investing for the first time. I'm mostly investing in index funds, but I may want to occasionally move my investments around to stocks, other index funds, or move to cash to ride out stormy markets. The problem is, I'm worried that if I do so before that money has been sitting there for at least a year, it will be taxed as a short term investment, so I'm hesitant to move anything around.

My question is: At what point are my investments considered "sold" for tax purposes? Is it when I sell them within my investment account, or is it not until I actually withdraw from the account? Basically I want to know if I am free to redistribute my money to new investments without fear of getting taxed each time I make a transaction.

Answer 1

Unless your investments are held within a special tax-free account, then every sale transaction is a taxable event, meaning a gain or loss (capital gain/loss or income gain/loss, depending on various circumstances) is calculated at that moment in time. Gains may also accrue on unrealized amounts at year-end, for specific items [in general in the US, gains do not accrue at year-end for most things].

Moving cash that you have received from selling investments, from your brokerage account to your checking account, has no impact from a tax perspective.

Answer 2

An investment is sold when you sell that particular stock or fund. It doesn't wait until you withdraw cash from the brokerage account. Whether an investment is subject to long term or short term taxes depends on how long you held that particular stock. Sorry, you can't get around the higher short term tax by leaving the money in a brokerage account or re-investing in something else.

If you are invested in a mutual fund, whether it's long or short term depends on when you buy and sell the fund. The fact that the fund managers are buying and selling behind your back doesn't affect this. (I don't know what taxes they have to pay, maybe you really are paying for it in the form of management fees or lower returns, but you don't explicitly pay the tax on these "inner" transactions.)

Your broker should send you a tax statement every year giving the numbers that you need to fill in to the various boxes of your income tax form. You don't have to figure it out. Of course it helps to know the rules. If you've held a stock for 11 1/2 months and are planning to sell, you might want to consider waiting a couple of weeks so it becomes a long term capital gain rather than short term and thus subject to lower tax.

Answer 3

This answer is about the USA.

Each time you sell a security (a stock or a bond) or some other asset, you are expected to pay tax on the net gain. It doesn't matter whether you use a broker or mutual fund to make the sale. You still owe the tax.

Net capital gain is defined this way:

Gross sale prices less (broker fees for selling + cost of buying the asset)

The cost of buying the asset is called the "basis price." You, or your broker, needs to keep track of the basis price for each share. This is easy when you're just getting started investing. It stays easy if you're careful about your record keeping.

You owe the capital gains tax whenever you sell an asset, whether or not you reinvest the proceeds in something else. If your capital gains are modest, you can pay all the taxes at the end of the year. If they are larger -- for example if they exceed your wage earnings -- you should pay quarterly estimated tax. The tax authorities ding you for a penalty if you wait to pay five- or six-figure tax bills without paying quarterly estimates.

You pay NET capital gains tax. If one asset loses money and another makes money, you pay on your gains minus your losses. If you have more losses than gains in a particular year, you can carry forward up to $3,000 (I think). You can't carry forward tens of thousands in capital losses.

Long term and short term gains are treated separately. IRS Schedule B has places to plug in all those numbers, and the tax programs (Turbo etc) do too.

Dividend payments are also taxable when they are paid. Those aren't capital gains. They go on Schedule D along with interest payments.

The same is true for a mutual fund. If the fund has Ford shares in it, and Ford pays $0.70 per share in March, that's a dividend payment. If the fund managers decide to sell Ford and buy Tesla in June, the selling of Ford shares will be a cap-gains taxable event for you.

The good news: the mutual fund managers send you a statement sometime in February or March of each year telling what you should put on your tax forms. This is great. They add it all up for you. They give you a nice consolidated tax statement covering everything: dividends, their buying and selling activity on your behalf, and any selling they did when you withdrew money from the fund for any purpose.

Some investment accounts like 401(k) accounts are tax free. You don't pay any tax on those accounts -- capital gains, dividends, interest -- until you withdraw the money to live on after you retire. Then that money is taxed as if it were wage income.

If you want an easy and fairly reliable way to invest, and don't want to do a lot of tax-form scrambling, choose a couple of different mutual funds, put money into them, and leave it there. They'll send you consolidated tax statements once a year. Download them into your tax program and you're done.

You mentioned "riding out bad times in cash." No, no, NOT a good idea. That investment strategy almost guarantees you will sell when the market is going down and buy when it's going up. That's "sell low, buy high." It's a loser. Not even Warren Buffett can call the top of the market and the bottom. Ned Johnson (Fidelity's founder) DEFINITELY can't.