How Investment Income is Taxed


in today’s video we’re gonna talk about
how the money you make from investing is taxed hey wealth builders and welcome
back to another episode of the bemused if you’re new around here my name is Akeiva
and on this channel we talk about all things money for young adults just like
me so if you’re into that I hope that you come join the squad by hitting that
subscribe button and turning on that notifications while you’re at it so that
you never miss when we post new videos so this video is our fourth video in our
investing series so if you’re new to investing and you want to learn more
about how to get started I suggest you go back from the beginning I’ll make
sure I put a card up here so that you can go and watch this series from the
beginning so far we’ve covered what investing is we’ve covered some crucial
definitions that you need to know before making the plunge into investing in our
last video we talked about several popular investment vehicles like stocks
ETFs mutual funds talk about the differences between them and how they
work so now that we’ve got that covered we’re gonna talk about how the money
that you make from investing is taxed so big disclosure in this video we are
focusing on investments that are held outside of like a retirement account or
any other tax deferred type of account we’re just focusing on investments that
are owned in your traditional taxable brokerage accounts best super-important
now to set the stage for this video I’ve got four more definitions for you guys
the first of which is ordinary income now ordinary income is any income that
the government will tax at your regular ordinary tax rate and by the way if you
want to learn more about how taxes work and how these tax rates work we actually
have a series on taxes completely devoted to taxes that we did back in the
beginning of this year so I also put a card up here if you want to go check
that out as well in case you want to learn more about how taxes work as well
so I think that’ll help you understand this video a whole lot more second is a
capital gain a capital gain occurs when you sell certain investments for more
than what you paid for them or your basis now this income is taxed at a
preferential rate it’s not taxed as highly as ordinary income and I’ll put a
graph on the screen right now to show you the difference between your ordinary
income tax rate and your capital gains tax rate now you have a capital gain
situation when you sell an investment for more than what you paid for it
you have also created a recognized gain and in most cases you’ll pay that
capital gains rate that preferential rate on the amount of the recognized
capital gain however in some situations the IRS only taxes you on what’s known
as a realized gain so the realized gain is basically your recognized gain
subtracting out any fees or costs that it took for you to be able to sell that
investment now that might sound a little bit confusing so let’s put it into
context and look at an example so let’s start with stocks in the last video we
mentioned that you can make money investing in stocks in two ways from
appreciation and from dividends so let’s talk about appreciation let’s say for
example that you bought a share of Netflix for $5 two years ago now it’s
worth $15 and you sell that stock however your brokerage platform charges
you a $1 fee to sell that stock so here’s what happens from a tax
perspective so because you bought $5 your basis and sold it $15 your capital
gain and your recognize game is $10 however because you had to pay that $1
fee to sell your stock your realized gain is $9 so that is the amount that
you’ll get taxed on and because you held the stock for more than one year you’ll
pay capital gains that preferential lower tax rate on that $9 game so your
tax bill would be between a zero percent and 20 percent of that nine dollars
depending on which tax bracket you fall into now what would have happened if you
only helped the stock for six months you’re recognized and realized gains
remain the same however what changes is the
tax rate that you have to pay if you hold that investment for less than a
year you cannot get that preferential capital gains rate you would have to pay
your ordinary income tax rate on that income so if you hold it for less than a
year your tax bill would then be higher as opposed to waiting a full year plus –
so so how do you keep track and know which stocks you’ve bought and sold
during the year for how much and how long you held them at the end of each
calendar year your brokerage platform will give you a form 1099 B and this is
what it looks like right here you then use this form 1099 B to file your taxes
and if you care to know specifically where your tax return that information
is reported it is reported on a form 8949 which ultimately flows through to
Schedule D of your form 1040 so what about dividends that you get from stocks
now if you hold a dividend paying stock you really don’t have a say as to
whether or not you receive that income if a dividend is issued you’re gonna get
that income whether you want it or not so if you receive dividend income from
stocks that income is gonna be reported on a form 1099 div and this is what that
looks like these dividend payments are subject to
capital gains rate so it gets that preferential tax treatment and that is
valid whether or not you chose to reinvest your dividends once you receive
a dividend it’s gonna be taxed the form 1099 zip will give you a breakdown as to
which dividends qualify as qualified dividends and which ones are not
qualified dividends and the difference between the two is that qualified
dividends and that’s typically most stocks that most people are trading with
typically be qualified dividends those will qualify for the preferential
capital gains rates qualified dividends are those paid by US companies and
international companies that have special treaties with the US if the
dividends are from a foreign country that doesn’t have that treaty that would
be considered a non-qualified dividend and that will be taxed at your ordinary
income tax rate as opposed to your capital gains tax rate now let’s talk
about bonds there are three types of bonds out there
first is the bonds that you buy from a company or corporation the interest or
income from these is generally taxable at both the federal
and state and local levels at your ordinary income tax rates the second
type is a US Treasury or government bond so these bonds though they’re subject to
federal taxation most of the time they do not get taxed at the state and local
level third is municipal bonds now municipal
bonds are bonds that are issued by your local government so like your county or
a city interest income generated by municipal bonds is generally tax-free on
both the state and federal levels assuming that you live in the state that
the bond is issued from an interest received from bonds including municipal
bonds even though generally those are not
taxable they’re still gonna be reported on a form 1099 int like as an interest
1099 int or a form 1099 oh ID now what about income from the sale of a bond
that income is treated like capital gains including municipal bonds so if
you sell a municipal bond for more than what you paid for it you’re gonna pay
capital gains tax on that now the calculation of the gate on a sale of
bonds can get pretty complicated because there are bonds that can be bought at a
premium or a discount meaning more or less than the face value of the bond so
it gets a little tricky there and we’re not gonna get into that in this series
but just know that if you do have a capital gain with the sale of a bond you
will have to pay capital gains tax on that taxation of pool vehicles such as
ETFs and mutual funds work in a similar way because remember when you buy a
pooled investment like you need to have a mutual fund you’re essentially buying
small chunks of the underlying investments however with an actively
managed mutual fund like we talked about last time you have an actual person or
team buying and selling and picking and choosing those underlying assets so that
buying and selling within the fund which is known as turnover in the investment
world has a potential to generate more income for you has the potential to
generate more gains because of how frequently they’re selling and buying
assets within that fund and of course you have no control over what they buy
and sell so if the income is generated you have no choice but to pay the tax on
it now let’s talk about Reese generally dividends that are paid out by real
estate investment trusts are taxed as ordinary income sometimes but not very
often they could be considered qualified dividends which you can’t qualify for
capital gains rates but that is in the very my new scenario a portion of the
dividends that you get from a REIT could also be considered a return of your
capital or return of your basis of your investment into that trust
therefore when that happens you don’t get taxed on the total amount of the
dividend you’re only taxed on the portion that is
considered a true dividend but whenever you sell that reinvestment your basis
will be reduced which could result in a higher capital gains tax bill at the
time that you sell your investment we have two more videos coming out for you
guys in this investment series in our next video we’ll be talking about the
practical ways how to get started we’ll be talking about micro investing a
couple of different platforms I know some of you guys have asked specifically
about specific investment platforms so we’re gonna cover a little bit of those
in the next video as well as are the ways that you can get started with
investing with low sums of money so make sure you stick around for that video so
I hope this video was valuable for you guys once again if you have not already
make sure you subscribe and hit that notification bells that you don’t miss
me post new videos if you have any investing related questions make sure
you leave those in the comments below as you guys know we typically get back to
every single one of you guys so drop your questions down below thanks so much
for spending this time with me and I’ll see you in the next video

8 Replies to “How Investment Income is Taxed

  1. you can make your own tax life a lot easier by not automatically reinvesting dividends, and not daytrading in and out of the same stock, and not selling just a few shares of a position . Better off to just buy and hold in taxable accounts from a tax viewpoint. The wash sale rules create a lot of hassle as well. You can go wild in IRAs tho…

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