Pub. 550: How to Report Investment Income and Expenses

The Internal Revenue Service (IRS) provides Publication 550, “Investment Income and Expenses,” as a guide for the tax implications of investment activities. This publication details the rules for reporting income from interest, dividends, and capital gains, and it outlines deductible expenses. This article simplifies the core concepts of Publication 550 to provide a foundational understanding of how to report common investment transactions on your tax return.

Reporting Interest and Dividend Income

Two of the most frequent forms of investment income are interest and dividends. Interest income can be generated from sources including bank accounts, money market funds, and corporate or government bonds. A primary distinction is between taxable and tax-exempt interest. For instance, interest from corporate bonds is federally taxable, while interest from municipal bonds is often exempt from federal income tax. Interest from U.S. Treasury securities is subject to federal tax but is exempt from state and local taxes.

Dividend income represents a distribution of a company’s earnings to its shareholders and is categorized as either ordinary or qualified. This classification has significant tax consequences, as ordinary dividends are taxed at the investor’s regular income tax rate. Qualified dividends are taxed at lower long-term capital gains rates, which can result in substantial tax savings.

For a dividend to be considered qualified, it must have been paid by a U.S. corporation or a qualified foreign corporation. The investor must also have held the stock for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date.

Payers report interest on Form 1099-INT and dividends on Form 1099-DIV. These forms detail the income earned during the year. If your total taxable interest or ordinary dividends exceed $1,500, you must report the income on Schedule B of Form 1040.

Understanding Capital Gains and Losses

A central aspect of investment taxation is the treatment of capital gains and losses, which arise from the sale of capital assets like stocks and bonds. The gain or loss is the difference between the sale proceeds and your basis in the asset. Understanding basis is fundamental to correctly calculating these figures.

The basis of an asset is typically its original cost, including any commissions paid to acquire it. This basis can be adjusted over time due to events like stock splits or reinvested dividends, resulting in an adjusted basis. For example, if you buy 100 shares of stock for $5,000 and pay a $10 commission, your cost basis is $5,010. If you later sell those shares for $7,000 and pay a $10 commission, your proceeds are $6,990, and your capital gain is $1,980.

The tax rate applied to a capital gain depends on the holding period. Assets held for one year or less generate short-term capital gains, taxed at the investor’s ordinary income tax rate. Assets held for more than one year result in long-term capital gains, which are taxed at more favorable rates (0%, 15%, or 20% for most taxpayers).

Your broker issues Form 1099-B, which details the proceeds from sales and may also report the cost basis. Taxpayers use this information to complete Form 8949, where each individual sale is detailed. The totals from Form 8949 are then summarized on Schedule D, which is attached to Form 1040.

Finally, investors must net their capital gains and losses. Short-term gains and losses are netted against each other, as are long-term gains and losses. If a net capital loss results, taxpayers can deduct up to $3,000 of that loss ($1,500 if married filing separately) against other income in a given year. Any loss exceeding this limit can be carried forward to future tax years.

Allowable Investment Expense Deductions

The Tax Cuts and Jobs Act of 2017 (TCJA) suspended the miscellaneous itemized deduction that was subject to a 2% of adjusted gross income floor. This change, effective through 2025, eliminated the ability for most individual investors to deduct expenses such as investment advisory fees, fees for a safe deposit box, and subscriptions to financial publications.

With the suspension of many deductions, the primary remaining deduction for investors who itemize is for investment interest expense. This deduction pertains to interest paid on money borrowed to purchase taxable investments, such as buying securities on margin. The deduction is calculated using Form 4952, and you cannot deduct interest on loans used to purchase tax-exempt securities.

The amount of investment interest you can deduct in a year is limited to your net investment income. Net investment income includes taxable interest and ordinary dividends, but it does not include qualified dividends or long-term capital gains unless the taxpayer elects to treat them as investment income. Any investment interest expense that exceeds this limit can be carried forward to subsequent tax years.

Transaction costs, such as brokerage commissions and fees, are not deducted as a separate expense. Instead, they are incorporated into the basis of the investment. When you purchase a security, these fees are added to the cost basis, and when you sell, they are subtracted from the sales proceeds, which reduces the capital gain or increases the capital loss.

Key Rules for Investment Transactions

Publication 550 details several specific rules, including the wash sale rule. This rule prevents a taxpayer from claiming a loss on the sale of a security if they purchase a “substantially identical” security within 30 days before or after the sale. This 61-day window is designed to stop investors from generating a tax loss while essentially maintaining their investment position.

If a loss is disallowed due to the wash sale rule, it is not gone forever. The disallowed loss is added to the cost basis of the new, replacement security. This postpones the tax effect of the loss until the new shares are eventually sold.

Higher-income investors may also be subject to the Net Investment Income Tax (NIIT). This is an additional 3.8% tax on the lesser of either net investment income or the amount by which a taxpayer’s modified adjusted gross income (MAGI) exceeds certain thresholds. The tax applies to investment income such as interest, dividends, and capital gains and is calculated on Form 8960.

Another situation covered is the treatment of worthless securities. If a security you own becomes completely worthless during the tax year, you can treat it as a capital loss. For tax purposes, the security is treated as if it were sold for $0 on the last day of the tax year, which determines if the loss is short-term or long-term. The loss is reported on Form 8949 just like any other capital loss transaction.