How Are Securities Taxed? Stocks, Bonds, and Capital Gains

Owning securities like stocks, bonds, and mutual funds is a common investment strategy. The act of owning and eventually selling these investments carries specific tax consequences that investors must navigate. This article explains the primary ways that income from securities is taxed, covering the rules for dividends and interest, and the tax implications when it comes time to sell.

Taxation of Investment Income

Income generated from securities you hold is a taxable event, with the treatment varying based on the type of income received. For stockholders, this often comes in the form of dividends. Dividends are classified as either qualified or non-qualified, a distinction that directly impacts the tax rate applied. Qualified dividends are taxed at the lower long-term capital gains rates, while non-qualified, or ordinary, dividends are taxed at an individual’s higher regular income tax rate.

For a dividend to be qualified, it must be paid by a U.S. or qualifying foreign corporation, and the investor must meet a specific holding period. The stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date. The ex-dividend date is the deadline to own a stock to receive its upcoming dividend. Certain payments, like those from tax-exempt organizations, do not meet the criteria for qualified dividends.

Interest income from bonds is another form of investment income. The taxability of this interest depends on the entity that issues the bond. Interest from corporate bonds is taxable at both the federal and state levels. In contrast, interest from municipal bonds, issued by state and local governments, is often exempt from federal income tax.

The tax benefit of municipal bonds can extend to the state level. If an investor purchases municipal bonds issued within their state of residence, the interest may also be exempt from state and local taxes. Interest income from Treasury securities, issued by the federal government, is taxable at the federal level but is exempt from all state and local income taxes.

Taxation of Investment Sales

When a security is sold, the financial outcome is either a capital gain or a capital loss, each with distinct tax implications. A capital gain occurs when you sell an asset for more than its original purchase price, while a capital loss happens when the sale price is lower. The tax treatment of these events is determined by how long you owned the security before selling it.

The holding period separates gains and losses into short-term and long-term categories. A short-term capital gain or loss results from the sale of a security held for one year or less. Short-term gains are taxed at your ordinary income tax rates, which are the same rates that apply to your wages and can range from 10% to 37% depending on your income bracket.

A long-term capital gain or loss arises from selling a security held for more than one year. Long-term gains receive more favorable tax treatment, with rates set at 0%, 15%, or 20%, depending on your taxable income and filing status. For many taxpayers, the rate is 15%.

The foundation for calculating any capital gain or loss is the security’s cost basis. The cost basis is the original price you paid for the security, including any costs such as commissions or brokerage fees. The capital gain or loss is the difference between the net sale proceeds and your adjusted cost basis. For example, if you buy 100 shares of stock at $50 per share with a $10 commission, your cost basis is $5,010. If you later sell all shares for $7,000, your capital gain is $1,990.

Determining the cost basis is more complex if you purchase shares of the same security at different times and prices. In this situation, you must have a method to identify which shares are being sold. The default method required by the IRS is First-In, First-Out (FIFO), where the first shares purchased are considered the first ones sold. Alternatively, you can use the Specific Identification method, which allows you to choose which lot of shares to sell, giving you control over the resulting gain or loss, provided you identify the shares to your broker at the time of sale.

Special Tax Rules and Considerations

Several specific rules can alter an investor’s tax liability. One is the wash sale rule, which prevents investors from claiming a loss on a security if they purchase a “substantially identical” security within a specific timeframe.

A wash sale occurs if you sell a security at a loss and then buy it back within 30 days before or after the sale date. If a transaction is identified as a wash sale, the IRS disallows the capital loss on the sale. The disallowed loss is added to the cost basis of the newly acquired replacement shares, deferring the tax benefit of the loss until the new shares are sold.

Investors can use tax-loss harvesting to manage their tax exposure by strategically selling investments at a loss to offset realized capital gains. Capital losses must first be used to offset capital gains of the same type; short-term losses offset short-term gains, and long-term losses offset long-term gains.

If excess losses remain, they can be used to offset gains of the opposite type. For instance, an excess short-term loss can offset a long-term gain. If an investor has more total capital losses than gains, up to $3,000 of the excess loss can offset ordinary income each year. Any remaining capital loss can be carried forward to future tax years.

Higher-income investors may be subject to the Net Investment Income Tax (NIIT), an additional 3.8% tax on investment income for those whose income exceeds certain thresholds. The tax applies to the lesser of your net investment income or the amount by which your modified adjusted gross income (MAGI) surpasses the threshold for your filing status. For 2025, these thresholds are $200,000 for single filers and $250,000 for those married filing jointly. Net investment income includes interest, dividends, and capital gains.

Reporting Security Transactions on Your Tax Return

At the end of the tax year, your brokerage firm will send you documents that summarize your investment activity. These forms are the foundation for accurately completing your tax return and reporting your gains, losses, and income.

You will receive Form 1099-B, which details every security sale you made, reporting the gross proceeds, cost basis, and whether the gain or loss was short-term or long-term. For income received, you will get Form 1099-DIV for dividends and Form 1099-INT for interest income.

The information from these forms is transferred to your tax return. Transactions on Form 1099-B are reported on Form 8949, Sales and Other Dispositions of Capital Assets. This form lists the details of each sale, including acquisition and sale dates, sale price, and cost basis, to calculate the gain or loss.

The totals from Form 8949 are carried over to Schedule D, Capital Gains and Losses. Schedule D consolidates your short-term and long-term gains and losses to calculate your net capital gain or loss for the year. This final figure is then entered on Form 1040 and combined with your other income to determine your total tax liability.