How do taxes on non-tax-advantaged accounts work?

[naners]

I'm new to investing in taxable accounts. How do they get taxed prior to drawdown? When do you have to pay capital gains tax: every year or just if you sell the funds? What about dividends? I do know enough not to put bonds in taxable accounts but beyond that I don't know how it works. Thanks!

[Tremeroy]

Hi naners. I am glad that you are interested in taxable accounts. While they are considerably more complicated than tax-advantaged accounts, it really isn't too confusing once you get the hang of it.

Buying & Selling

• When you purchase something, your purchase price (+ commission) is your "basis."
• When you sell something, you have a capital gain (or loss) by taking the sale proceeds (net of any commissions) and subtracting your basis.
• If, at the end of the tax year, you have sold any securities, you add together the capital gains & losses to determine your "net" capital gain or loss.
• If you have an overall gain, you would pay Capital Gains tax on that amount
• There are also specific rules depending on how long you own something (1+ years or <1 year)
• As a beginner, you really shouldn't be doing too much buying & selling during the year, so I am going to skip all of those details.
• Assuming that the gains are "long term" in nature (1+ years of ownership), the gains are taxed at the Long Term Capital Gains Rate (0%-23.8%, depending on your other income).

Dividends, Distributions, & Interest

• If you receive a "dividend" on a security that you've owned continuously for 60 days within the time period of (60 days before dividend is paid through 60 days after the dividend is paid), then it counts as a "qualified" dividend.
• Qualified dividends are taxed at the long-term capital gains tax rate
• If you receive "interest" on a security, such as a bond, you will generally pay taxes at the end of the year based on your normal marginal tax rate.
• In other words, it's just like you got a bonus from work (except there are no payroll taxes).
• The high tax rate is the reason that people generally don't own bonds in taxable accounts.
• REITs, MLPs, and other more complicated investments sometimes make cash distributions that can't be easily categorized as dividends or interest; the taxation on these types of investments is probably a bit too complicated for a beginner.
  

I hope that this helps get you started!

[oldmannickels]

Depending on what funds / stocks you hold in the taxable account you will received distributions throughout the year which can be classified as dividends, ordinary income, or capital gains depending on the fund.

Capital Gains taxes are assessed when you sell a fund if your basis is less than the selling price. They can also be assessed if the fund distributes capital gains it incurred during the year.

The capital gains rate in the US for capital gains and qualified dividends can be 0%, 15%, or 20% depending on your taxable income.

At the end of the year you will received a 1099 from your broker with the details to record on your tax return.

[ShoulderThingThatGoesUp]

Depending on what funds / stocks you hold in the taxable account you will received distributions throughout the year which can be classified as dividends, ordinary income, or capital gains depending on the fund.

Capital Gains taxes are assessed when you sell a fund if your basis is less than the selling price. They can also be assessed if the fund distributes capital gains it incurred during the year.

The capital gains rate in the US for long term capital gains and qualified dividends can be 0%, 15%, or 20% depending on your taxable income.

At the end of the year you will received a 1099 from your broker with the details to record on your tax return.

Long term capital gains mean gains on securities you've held for over one year. You pay a higher tax rate on short term capital gains. As you're here I expect you're not doing any market timing, so the only short term gains you'll see is if you reinvest dividends, which usually come quarterly, so any time you sell your position you'll have 4 quarters' worth of dividends of short term basis.

Why shouldn't you put bonds in taxable accounts? (Most people here invest that portion of their portfolio in a bond ETF like SCHZ or whatever the Vanguard equivalent is, so it's not exactly a bond for tax purposes.)

[Tremeroy]

Why shouldn't you put bonds in taxable accounts? (Most people here invest that portion of their portfolio in a bond ETF like SCHZ or whatever the Vanguard equivalent is, so it's not exactly a bond for tax purposes.)

• Bond interest doesn't receive favorable tax rates. It is taxed just like any other non-wage income (i.e. at your marginal rate).
• There are a couple of ways to work around the higher marginal rate:
• There is an itemized deduction for interest you pay for loans that are used to finance investments that can be used to offset any of your investment income (usually it's only used to offset interest & short-term capital gains).
• Municipal-bond interest often avoids taxation at the state level.

[naners]

Thanks very much everyone! Tremeroy, especially big thanks for the excellent breakdown. Sounds like if I don't sell then there's no capital gains. So, I will just rebalance through changing purchases.