How to Calculate Gain or Loss on Stock

When you sell a stock, the resulting profit or loss is a capital gain or loss, which has direct tax implications. A capital gain occurs when you sell a stock for more than you paid for it, while a capital loss happens when you sell for less. Accurately calculating this figure is a necessary step for fulfilling your tax obligations. The calculation determines how much tax you might owe or whether you can use a loss to offset other gains.

Determining Your Cost Basis

The cost basis is the original value of your stock for tax purposes. This value includes the purchase price plus any associated costs of acquisition, such as brokerage commissions or fees. The cost basis often requires adjustments over the life of the investment to ensure an accurate calculation and avoid paying more tax than required.

One common adjustment comes from reinvested dividends. When you use a dividend to automatically buy more shares, that amount is added to your cost basis. Since you already pay income tax on the dividend, this adjustment prevents you from being taxed on that money again when you sell the shares.

Corporate actions like stock splits also change your per-share basis. A 2-for-1 stock split, for example, doubles the number of shares you own but halves the cost basis of each share. Your total cost basis remains the same but must be reallocated across the new number of shares.

A return of capital also impacts your basis. Unlike a dividend, a return of capital is a distribution of your own investment money, not company profits. These distributions are not taxed when received but instead decrease your cost basis in the stock, which can increase your future capital gain.

The wash sale rule applies when you sell a stock at a loss and buy a substantially identical one within 30 days before or after the sale. Under this rule, the IRS disallows the loss for tax purposes in that year. The disallowed loss amount is then added to the cost basis of the newly purchased shares, which defers the tax benefit until the new shares are sold.

Your brokerage statements, trade confirmations, and the Form 1099-B provided by your financial institution contain the information for your initial purchase and any adjustments.

Identifying the Specific Shares Sold

When you sell a portion of your holdings in a stock acquired at different times and prices, you must determine which specific shares were sold. This choice can significantly alter the amount of your calculated gain or loss. The identification method you use is an important step in the process.

The default method required by the IRS is First-In, First-Out (FIFO). Under FIFO, the first shares you purchased are considered the first shares you sell. This is often the simplest method as it does not require you to specify which lot is being sold. Your broker will use FIFO for reporting unless you provide different instructions.

Alternatively, you can use the specific share identification method. This approach allows you to choose which lot of shares to sell, giving you control over the tax outcome. For instance, to minimize your taxable gain, you could sell the shares purchased at the highest price. You must identify the specific shares to your broker at the time of the sale to use this method.

Consider an investor who bought 10 shares of a company at $50 and later bought another 10 shares at $80. If they sell 10 shares at the current price of $100, the outcome differs based on the method. Using FIFO, they would sell the first lot, resulting in a $500 gain (($100 – $50) x 10). Using specific identification, they could sell the second lot for a smaller $200 gain (($100 – $80) x 10), lowering their immediate tax liability.

Calculating the Final Gain or Loss

After determining the adjusted cost basis and which shares were sold, you can perform the final calculation. Subtract the adjusted cost basis from the sale proceeds to find your capital gain or loss. The proceeds are the total amount received for the sale, less any selling costs. A positive result is a gain, while a negative result is a loss.

The holding period, which is the length of time you owned the stock, determines the tax treatment for your gain or loss. The holding period begins on the day after you acquire the stock and ends on the day you sell it. This distinction is important for tax planning.

If you hold the stock for one year or less, the profit or loss is classified as short-term. Short-term capital gains are taxed at your ordinary income tax rates, which are the same rates that apply to your wages and other income.

If you hold the stock for more than one year, the outcome is a long-term capital gain or loss. Long-term capital gains benefit from preferential tax rates of 0%, 15%, or 20%, depending on your taxable income and filing status. Higher-income investors may also be subject to a 3.8% Net Investment Income Tax on their capital gains. For example, a $2,000 gain on a stock held for 18 months would be a long-term gain subject to these lower rates.

Reporting on Tax Forms

After calculating your capital gains and losses, you must report them to the IRS on specific tax forms. You will transfer your calculated figures to these forms rather than recalculating them. The primary document for this is Form 8949, Sales and Other Dispositions of Capital Assets.

On Form 8949, you will list each stock sale transaction separately. For every sale, you must enter the proceeds, the cost basis, and any adjustments. The form is divided into parts for short-term and long-term transactions, so you must report each sale in the correct section based on its holding period.

The totals from Form 8949 are carried over to Schedule D, Capital Gains and Losses. Schedule D summarizes your total short-term and long-term gains and losses from all your transactions. On this form, you will net your gains and losses to get a net short-term figure and a net long-term figure.

The net gain or loss from Schedule D is transferred to your main tax return, Form 1040. This figure is included in the calculation of your total taxable income for the year. Both Form 8949 and Schedule D must be submitted with your Form 1040 when you file your annual tax return.