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Your top tax questions answered

7 minutes
March 07, 2024
Tax filing support

Tax season is upon us, and there's no better time to go over some of the basics, including taxation of different account types, capital gains and losses, and tax-loss harvesting.

Ready to get started?

How are taxable brokerage accounts and retirement accounts taxed?

With taxable brokerage accounts, you invest cash on which you've already paid income taxes, such as money from your paycheck. However, you may still owe taxes on future income or growth from these investments. For example, dividend income is taxed in the year you receive it, even if you haven't sold the investment, while the growth on capital gains is taxed when you sell your investment.

Retirement accounts such as traditional and Roth IRAs, as well as retirement plans like 401(k)s, are geared toward long-term saving and investing, so they receive special tax treatment. With traditional IRAs and 401(k)s, your contributions can be tax deductible in the year they're made with earnings taxed upon distribution. Contributions to Roth IRAs and 401(k)s are made with after-tax dollars, meaning you've already paid income taxes on the money you're contributing. And you won't pay taxes on qualified withdrawals of your earnings.1

What's capital gains tax and when do I pay it?

Capital gains tax is charged on profits made from the sale of an investment. In other words, if you sell an investment for more than you paid for it, you may owe capital gains tax on your earnings. The exact rate you'll pay is determined by your overall income level and how long you held the assets before selling. Unless you're required to make estimated tax payments, you'll pay capital gains tax when you file your income tax return.

Let's look at an example:

Let's say you buy 1 share of ABC Company for $10 in your taxable brokerage account. You later sell that share for $15. The result is a realized capital gain of $5. You'll only owe capital gains tax on the $5 profit, not the entire $15. The original $10 is considered your "cost basis"—the amount invested.

What are realized and unrealized gains?

You "realize" capital gains when you sell an investment in your taxable brokerage account for more than you paid for it. If your investment has increased in value and you haven't sold it, your gain is considered "unrealized." You don't owe capital gains tax on unrealized gains.

Does the length of time I own the investment affect my tax rate?

Yes, the holding period matters. If you've owned your investment for more than 1 year before selling at a gain, you're subject to long-term capital gains tax rates. If you've owned your investment for one year or less before selling at a gain, you're taxed at short-term capital gains rates.

To encourage long-term investing, long-term capital gains receive special tax treatment. Most individuals are taxed either 0%, 15%, or 20% on their realized long-term capital gains. Investors subject to short-term capital gains rates are taxed at their ordinary income tax rate, which can range from 0% to 37%.

What if I have more losses than gains?

If you sell your investment for less than you originally paid for it, you could be entitled to take a capital loss. When an investment is sold for less than its original purchase price, the difference in value is considered a capital loss. While we never want our investments to lose value, investors who realize a capital loss in their taxable brokerage accounts can potentially use that loss to lower their taxable income or offset future capital gains, through a strategy like tax-loss harvesting.

What's tax-loss harvesting?

Tax-loss harvesting is when you intentionally sell securities at a loss to offset capital gains. You can offset all your capital gains with losses during the same tax year, plus up to $3,000 of ordinary income if you're single or married, filing jointly (up to $1,500 each if you're married, filing separately). You can use this strategy to lower your tax liability when rebalancing your portfolio.

Tax-loss harvesting only applies to taxable brokerage accounts. It can be complex, but it offers a sophisticated way to turn market volatility into a tax-savings opportunity.

Interested in learning more about implementing this tax strategy and others? Vanguard Personal Advisor Select™ can help you maximize your after-tax returns.

Here's an example of tax-loss harvesting:

Suppose you're holding on to 1 share of ABC Company, which had a $5 gain, and 1 share of XYZ Company for $15, which had a $5 loss. If you sold both shares, your capital gain would be $0—the $5 loss would offset the $5 gain.

Now, imagine your 1 share of ABC Company had a gain of $10 and your 1 share of XYZ Company still had a loss of $5. If you sold both shares, your capital gain would be $5—the $5 loss would offset a portion of the $10 gain.

Additional tax resources

Income tax code is complicated, but here are some additional resources to support you every step of the way.

Tax center

Help for your common tax questions

As always, we encourage all our clients to seek guidance from qualified tax professionals when needed.

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Consider Vanguard Personal Advisor Select and see what we can do to help you this tax season and beyond.

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1When taking withdrawals from an IRA before age 59½, you may have to pay ordinary income tax plus a 10% federal penalty tax. For Roth IRAs, you won't pay taxes on withdrawals of your earnings as long as you take them after you've reached age 59½ and you've met the 5-year holding period, which starts on the earlier of the date you first contributed directly to the Roth IRA, rolled over a Roth 401(k) or Roth 403(b) to the Roth IRA, or converted a traditional IRA to the Roth IRA.

All investing is subject to risk, including the possible loss of the money you invest. Past performance is no guarantee of future results.

Tax-loss harvesting involves certain risks, including, among others, the risk that the new investment could have higher costs than the original investment and could introduce portfolio tracking error into your accounts. There may also be unintended tax implications. We recommend that you carefully review the terms of the consent and consult a tax advisor before taking action.

We recommend that you consult a tax or financial advisor about your individual situation.

Vanguard's advice services are provided by Vanguard Advisers, Inc. ("VAI"), a registered investment advisor, or by Vanguard National Trust Company ("VNTC"), a federally chartered, limited-purpose trust company.

The services provided to clients will vary based upon the service selected, including management, fees, eligibility, and access to an advisor. Find VAI's Form CRS and each program's advisory brochure here for an overview.

VAI and VNTC are subsidiaries of The Vanguard Group, Inc., and affiliates of Vanguard Marketing Corporation. Neither VAI, VNTC, nor its affiliates guarantee profits or protection from losses.

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