Points to know
- Capital gains are "realized" (and subject to tax) when you sell investments that have increased in value.
- Capital gains are subject to different tax rates depending on how long you owned the investment.
Capital gains are profits on an investment. When you sell investments at a higher price than what you paid for them, the capital gains are "realized" and you'll owe taxes on the amount of the profit.
Figuring out how much of your sale amount was made up of taxable earnings can be tricky. You'll first need to know how much you originally paid for the shares (your cost basis).
The investment returns you accumulate on the savings in your account.
Gains that are "on paper" only are called "unrealized gains." For example, if you bought a share for $10 and it's now worth $12, you have an unrealized gain of $2. You won't pay any taxes until you sell the share.
Unrealized gains could be very important if you invest in funds, however. When you buy shares of a mutual fund or ETF (exchange-traded fund), you're also "buying" any unrealized gains it has—and you'll be subject to their eventual taxation.
A type of investment that pools shareholder money and invests it in a variety of securities. Each investor owns shares of the fund and can buy or sell these shares at any time. Mutual funds are typically more diversified, low-cost, and convenient than investing in individual securities, and they're professionally managed.
A type of investment with characteristics of both mutual funds and individual stocks. ETFs are professionally managed and typically diversified, like mutual funds, but they can be bought and sold at any point during the trading day using straightforward or sophisticated strategies.
Long-term capital gains are gains on investments you owned for more than 1 year. They're subject to a 0%, 15%, or 20% tax rate, depending on your level of taxable income.
Short-term capital gains are gains on investments you owned 1 year or less and are taxed at your ordinary income tax rate.
Realized capital gains for individual securities are reported to you and to the IRS on Form 1099-B. Realized gains for funds are reported on Form 1099-DIV.
LONG-TERM CAPITAL GAINS & AMT
Realizing a capital gain that's large in comparison to the rest of your income could trigger alternative minimum tax (AMT). If you're planning to sell investments that have large capital gains, talk to a tax advisor about whether it could be a good idea to divide up the sale over 2 calendar years.
A federal income tax calculated separately from the regular federal income tax. It is designed to prevent taxpayers—particularly those with high incomes—from using certain deductions and credits (called tax-preference items) to pay little or no taxes.
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