Capital Gains from Trading and Investing

It is a fact of life that active traders and investors generate capital gains and losses - lots of them! The very nature of trading calls for buying and selling the same stocks and / or options over and over again.

When you trade or invest in equities such as stocks, options, bonds, mutual funds, and other capital assets, you may owe a capital gains tax on the profits from the sale of those investments.

Calculating Capital Gains

In a nutshell, the capital gain from the sale of an investment is calculated by subtracting your basis in the asset you sold, from the amount you realized in the sale. Your basis is your cost or the purchase price plus brokerage commissions and SEC fees. The amount realized is what you received from the sale, less brokerage commissions. Of course, when the cost basis is higher than the amount realized from the sale, the result is a capital loss.

Traders and investors also receive ordinary income, which includes dividends and interest. Ordinary income is not considered a capital gain, therefore dividends and interest are not part of your capital gain calculation.

It is also important to note that capital gains are taxed as net, meaning any losses in the tax year can offset the gains for the same period resulting in a net gain or loss. Capital gains and losses are typically reported on an IRS Form 1040, Schedule D for tax filing. However, not all investments are reported on a Schedule D. We'll discuss more in the topic Which Form to File?.

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Benefits for Active Traders

Active traders benefit from generating capital gains instead of ordinary income for two reasons:

1. IRS capital gains taxes are not paid until the security is sold and a profit is realized, so an active trader can time the sale of the security based on whether they want to claim a capital gain or loss. However, an investor has no control when interest and dividends are distributed
2. Certain types of capital gains are taxed at much lower rates than ordinary income. For example, long-term capital gains are typically taxed at a lower rate to encourage investment in the economy and entrepreneurship.

As each type of capital gain has a different tax treatment, successful traders often select their investments and time their trades to produce specific tax results. TradeLog™ offers the active trader an automated way to log all their executed trades and run quick, concise reports that allow them to keep a handle on their capital gains and losses throughout the year.

Learn about capital gains holding periods.