So I’m Taxed If I Make Money, But What If I Lose Money?

As an investor, you are guaranteed to make money, right?

That would be nice, but we know you can and will lose money on some investments. So what happens if you buy a stock at $100 and then sell it later for $75? After you have a good cry, you then need to figure out how much your loss is. Fortunately, this is 3rd grade math simple. You lost $25.

Couple of things to know here:

First, you bought the stock at $100. Instead of saying, “That’s what I bought it for,” we say your basis is $100. Basis is important because that’s how you know if you’ve gained or lost money. When you first buy an investment, what you paid is typically your basis. But, over time, your basis can change.

For example…

Let’s say you buy a rental house for $250,000. Your basis in the rental house is $250,000. But then you have to fix up the house and yard for $25,000. All the money you spent on those improvements is added to your original basis, so now your new basis is $275,000. Why is this important? Taxes, of course! If we didn’t have to pay taxes on our gains, it wouldn’t really matter. But let’s say you sell the house for $300,000. All of a sudden, we care what the basis is. If it’s $250,000, then we have a capital gain of $50,000. But if the basis is $275,000, then our gain is only $25,000. That’s a big difference.

Today, firms such as Schwab or Fidelity where you invest in stock, bond, and mutual fund investments will keep track of your basis for you.

In fact, if you go online to your investments, they will have a link where you can see all of your investments and the basis and gain/loss for each. It’s pretty slick and it gives you a quick snapshot of what you have and what your gains or losses are for each investment, as well as for your whole account.

Okay, back to the investment you bought for $100 and sold for $75.

Is it a gain or loss?

Correct. You have a capital loss of $25. This is important because you may be able to do some cool tax tricks with this loss.

Each year, as you know, you have to file your taxes. This is the 1040 tax return where you have to list all your income and other items. Each year, you also have to tell the IRS if you had any gains or losses on your investments. But what if you have gains and losses on different investments? You made $100 on one investment but lost $25 on another. The IRS lets you net all your gains and losses together. So even though you had this $100 gain, you can subtract the $25 loss from this and end up with just a $75 capital gain that gets taxed. Of course, there are lots of rules and details, but that’s the gist.

So what’s the number one question everyone has on April 15?

If you don’t know already, you’re going to next.

The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.