Please explain how capital gains tax works in U.S.?

Question

Let's use an example for clarity.
Say you buy 100 shares of XYZ stock at $10 for $1000.
Six month later you buy another 50 shares of XYZ at $15, or $750 for this trade.
Another six month later you sell 75 shares of XYZ at $20 and receive $1500 for this trade. (After this you still have 75 shares left.)

Ignoring commissions, how much capital gain/profit do you report on that sale of 75 shares?
How much tax might you pay on that sale if you're already at the maximum tax bracket in your state?

Thanks in advance.

Answer 1

Depends upon which shares you sold. You have to stipulate which shares you're selling.

If the 75 sold were all from the first purchase, you'd have $750 in gain. If they were all of the second buy and 25 from the first, it would be $500. Any other mix would be somewhere between the two.

The Federal tax will depend upon how long you held the shares. In the example given, it's all short term gain since you owned the shares for 1 year or less. That's taxed at your margainal rate. If you held some of all of them for over 1 year, that would be taxed as a long term capital gain, usually at 15% but that can vary between 5% and 28% depending upon your marginal tax rate.

State taxes are impossible to say as there are 50 states and not all of them have an income tax and those that do all treat it a bit differently.

Answer 2

You need to record the dates purchased and sold

Say
a) Feb 1, 2005 Buy 100 XYZ @$10 =( $1000)
b) July 1, 2005 Buy 50 XYZ @ $15 = ($750)
c) Feb 1, 2006 Sell 100 XYZ @$20 = $1500

The capital gain depends on what block of stock you sold...the a) or the b)

Assuming you sold a)
You have the $1500 earned on the $750 you invested in
a) for a net of $750 earned. You pay taxes on this

You have 25 sh of XYZ @10/sh remaining, plus the 75 sh of XYZ at $20/sh

Assuming you sold b)
You would sell all of b) plus 25 shares of a). The earning would be $1500 -(50sh x $15)-(25sh x $10). = $500
Here you have only 75sh of XYZ at $10 left.


There is a different tax for long held stocks and short held stocks...so that helps determine what you may want to sell

Answer 3

If you sold specific shares, you can sell the 50 shares you bought at $15, total cost $750, and 25 of the shares you bought at $10, cost $250, total cost for 75 shares sold $1000, for a gain on the sale of $500, with basis for the 75 shares you still have left of $750.

If you don't specify which shares are sold, then FIFO rules are in effect, so the first 75 shares you bought are considered to be sold, basis $10 each or $750 - your remaining shares would then carry a basis of $1000, and your gain on the sale would be $750.

Your federal income tax on the sale would be 5% or 15% depending on what tax bracket you are in, if they were long term (held over a year) but would be short term, taxed at ordinary income rates, in your scenario since the holding period would be at most one year, just under the long term limit. State income tax would depend on what state you're in, since maximum rates vary substantially from state to state.

Answer 4

First you have to choose which shares you sold. A typical methodology is first in, first out (FIFO) though other methodologies can be used.

In your example under FIFO, the 75 shares sold would be eligible for capital gains treatement because you held the stock for a year. You sold for $20 on something which you acquired at a historical basis $10. You pay capital gains taxes on the gain of $10. On 75 shares that is $750 capital gain. The tax rate on capital gains is 20%. So the tax is $150. This assumes you have no other capital losses which could offset the gain.