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Understanding the Taxability of Your Investment Portfolio

navigating investment taxes
Understand the nuances of investment income taxation and its impact on your portfolio strategy.

In my last article, I wrote about understanding your investment performance. We broke down the differences in investment performance, explaining in detail both short and long- term capital gains, dividend income, and interest income.

It is equally as important that you understand the taxability of your various investment income streams. Each category of your investment income is subject to different tax rules. Investment taxability is a factor that should influence your portfolio strategy. Some investment strategies are more tax-efficient than others. An active trading strategy will have more investment turnover, creating tax implications in a taxable account (like a traditional brokerage account or trust account) versus a more passive “buy and hold” strategy with little turnover. Also the type of investment vehicle (like a mutual fund, ETF, or individual stock) will differ in the taxability they generate for clients.

The taxability of different account types:

A traditional brokerage account, whether held jointly, individually, or in trust is taxable in the year that the gain or income was received. Investors will pay taxes on those capital gains, dividends, or interest income when they Eile their taxes every year.

A qualified account like a traditional IRA, SEP IRA, SIMPLE IRA, or 401(k) is tax deferred. Taxes are not paid on any earnings until they are withdrawn, and then when they are withdrawn, they are taxed at ordinary income tax rates.

Gains, dividend income, and interest income are not taxed in a Roth account, as all earnings and withdrawals are tax-free.

Capital Gains

In my last newsletter, I explained to you the difference between realized capital gains and unrealized capital gains. Currently, investors will only be taxed in a brokerage account when they realize a capital gain by selling an investment, or if they own a mutual fund that makes a capital gain distribution due to the manager selling stocks within the fund.

It is important to note that there is a difference between a short-term capital gain, which is defined as an asset held for one year or less, and a long-term capital gain, which is an asset held for more than one year. Currently, short-term capital gains are taxed at ordinary income tax rates, just like your salary. Long-term capital gains are taxed at a lower amount, and in a range that is dependent upon your household income. At present, long-term capital gains tax rates vary based on income levels:

  • For individuals in the lowest tax brackets, long-term capital gains may be taxed at 0%. -Those in middle-income brackets generally face a long-term capital gains tax rate of 15%.

  • Individuals in the highest income brackets may be subject to a long-term capital gains tax rate of 20%.

  • Additionally, a 3.8% Net Investment Income Tax (NIIT) may apply to certain investment income, including capital gains, for individuals with higher incomes.

Here is an example: Imagine you bought a stock for $100 and sold it later for $150. The $50 increase in the sales price over what you paid is the reported capital gain. If you held this stock for less than a year, that $50 would be taxed at ordinary income tax rates. If you held it for over a year, that $50 would be at your lower capital gains rate.

Capital losses

A loss occurs when you sell an investment at a loss. Currently, capital losses can be used to offset capital gains. Also, losses not used to offset capital gains can be deducted up to $3,000 a year and can also be carried over until used up. For example, if you have $10,000 of realized capital gains and $15,000 of realized losses your net loss is ($5,000). You can wipe out all of the $10,000 capital gain, use ($3,000) loss on your tax return and carry the extra ($2,000) loss over to next year’s taxes.

Interest income

When you earn interest on investments like bonds, money market funds, savings accounts, CDs, or any other interest that you earn, this income is taxed as ordinary income. This amount will be added to your salary and taxed at your regular tax rate. Some investments may be exempt from federal and/or state income tax, for example, municipal bonds, tax- free money market funds, and certain treasuries.

Interest earned on an investment in qualified retirement accounts, like 401(k)s and traditional IRAs is also not taxable until withdrawal. Interest earned in Roth, IRAs, and Roth 401(k) is completely tax-free.

Dividend Income

Dividend income is a payment made by a company to its shareholders. Dividend income can be classified as qualified or non-qualified which affects how they are taxed. Qualified dividends are taxed at the same rates as long-term capital gains, which is generally lower than ordinary income tax rates. Non-qualified dividends are taxed as ordinary income, similar to interest income.

We hope this helps you understand the taxability of your investments. For more details on your personal tax situation, and if you have questions about your portfolio, please reach out to your advisor to schedule a meeting.


Abigail Skipper

This presentation is not an offer or a solicitation to buy or sell securities. The information contained in this presentation has been compiled from third party sources and is believed to be reliable; however, its accuracy is not guaranteed and should not be relied upon in any way, whatsoever. This presentation may not be construed as investment advice and does not give investment recommendations. Any opinion included in this report constitutes our judgment as of the date of this report and are subject to change without notice. Certain risks exist with any type of investment and should be considered carefully before making any investment decisions. 

Additional information, including management fees and expenses, is provided on our Form ADV Part 2 available upon request or at the SEC’s Investment Adviser Public Disclosure website.  Past performance is not a guarantee of future results.


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