The actual sale of common stock is a pretty simple process. Just place the sell order with your broker, and she handles the details and credits your account with the proceeds. However, shares of common stock are a capital asset, and you’ll end up with a taxable gain or deductible loss when you sell them. Your sale of common stock isn’t finished until you take care of the tax consequences.
A capital gain or loss on common stock is a taxable event only when the shares are sold. To determine the gain or loss, you first calculate the cost basis. Basis is your total investment in the stock, and includes the money paid for the shares plus other purchase expenses such as broker’s commissions. Suppose you bought 100 shares of XY Company common for $40 per share and paid a commission of $50, for a total of $4,050. Later, you add another 50 shares at $50 per share and pay your broker a $30 commission. That’s an additional investment of $2,530. Your total cost basis adds up to $6,580.
Companies often offer dividend reinvestment plans that allow you to buy more shares with your dividend payments instead of taking the money in cash. The Internal Revenue Service defines dividends on common stock as ordinary income and you must pay income taxes on the money. For tax purposes, it’s as if you received the dividends in cash. For this reason, the reinvested dividends are after-tax dollars that increase your total investment and therefore add to the cost basis of the common stock you own.
Gains and Losses
To figure the gain or loss on the sale of common stock, subtract sales fees from the price you receive for the shares to find your net proceeds. Then subtract your cost basis. Suppose you sell 150 shares of XY Company common for $60 per share, minus a $100 broker’s commission. Your net proceeds equal $8,900. If your cost basis is $6,580, subtract this to find your capital gain of $2,320. If the cost basis is more than the net proceeds, you’ll get a negative amount as an answer, which means that you took a loss on the investment.
When you sell common stock, keep track of the length of time you owned the shares. If you hold the stock for more than one year, it’s a long-term capital gain, subject to a maximum tax rate of 15 percent, as of 2012. When you own the shares for one year or less, the gain is short term and taxable at a maximum rate of 35 percent. If you purchased the shares at different times and some qualify as long-term but not others, calculate the sale of short- and long-term gains separately, even if the shares were sold in a single transaction. Keep track of short- and long-term losses just as you do gains. This is necessary because when you prepare your tax return, you must use long-term losses to offset long-term gains, and short-term losses to offset short-term gains.