Investment TaxationInvestment Taxation

As you get ready to file your taxes, you may be wondering about investment taxation. In this article, we will go over the basics of how your investments are taxes so you can prepare to file your taxes.

Different Types of Income

One of the factors that determine your taxation is the type of income that your investment earned. There are several different ways your investment can create income. These include:

  • Interest Income: If your investment earns interest, it is a form of investment income.
  • Selling Your Investment: If you sell your investment you can either generate income or lose income.
  • Dividend Income: If you receive any dividends, it is investment income.

Ordinary Income

After you have determined what type of income your investments generate you will need to determine how that income will be taxed. One form of taxation is ordinary income.

Typically, interest-bearing investments are taxed as ordinary income. This would include such things as savings accounts, certificates of deposit, money market accounts, annuities, bonds, and some preferred stocks.

Within ordinary income, there are several subcategories:

  • Taxable Income: This type of income is not tax-exempt or tax-deferred. You will report this income on your tax return in the year that you earned it. You will detail the income on your Schedule B.
  • Tax-Exempt Income: This type of ordinary income is free from federal or state income tax. Usually, municipal bonds and US securities are tax-exempt.
  • Tax-Deferred Income: If your income is tax-deferred, it means that the taxation is postponed to a future date. Tax-deferred investments include such things as a 401(k) or Traditional IRA.


Cost Basis

Cost basis is another term you need to be familiar with as you calculate your investment taxation. Your cost basis is the amount of your investment in an asset. There are two different types:

  • Initial Basis: The initial basis is your cost, what you paid for the investment. For example, if you purchased a stock for $100, your initial basis would be $100.
  • Adjusted Basis: Your adjusted basis is your initial basis adjusted to reflect any increases or decreases to your basis over time. For example, if you bought a rental home for $100,000 your initial basis is $100,000. Then if you install a pool for $10,000, your adjusted basis would be $110,000.

Capital Gains and Losses

Besides ordinary income, capital gains or losses are the second type of taxes that you can pay. You accrue capital gains or losses when you sell stocks, bonds, or capital assets.

If you sell your investment for more than the adjusted basis, then you will have capital gains. For example, if your stock has an adjusted basis for $100, and you sell it for $150, you will have a capital gain of $50. If you sell your investment for less than the adjusted basis, you have a capital loss.

You report and calculate your capital gains and losses on Schedule D of your tax return. To do this, you will need the following information:

  • Adjusted Basis
  • Amount Realized from Sale
  • Holding Period: This is how long you owned the asset. It is short-term if you owned it for one year or less. It is long-term if you held if for more than one year.
  • Marginal Income Tax Bracket: Your marginal tax bracket decides your marginal tax rate. This is based on your filing status and your level of taxable income. The tax rate that you will have to pay on your capital gains is based on your marginal income tax bracket.
  • Type of Asset(s): What type of asset you sell dictates the capital gains rate that applies.

Any capital losses you may incur can offset your capital gains and reduce your tax liability. You can deduct capital losses up to $3,000. However, you cannot use losses from this year to offset future gains.


Figuring out your investment taxation can be extremely complex. If you feel stuck or unsure, meet with a qualified tax preparer. They can do all of the calculations for you. They can also give you tips on how to reduce your taxes for the next year.

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