Taxes & Investing

Capital gains — short-term vs. long-term

A capital gain is the profit you make when you sell an investment for more than you paid. If you held it for one year or less, it's a short-term gain, taxed at your regular income tax rate. If you held it for more than a year, it's a long-term gain, taxed at a lower, separate capital gains rate.

This difference can be substantial — long-term rates are often significantly lower than short-term/ordinary income rates for the same person. Simply holding an investment past the one-year mark before selling can meaningfully change your tax bill.

How dividends are taxed

Dividends come in two flavors for tax purposes: "qualified" dividends, taxed at the same lower long-term capital gains rates, and "non-qualified" (ordinary) dividends, taxed at your regular income rate. Most dividends from U.S. stocks held for a minimum holding period qualify for the lower rate, but not all do.

This is one more reason account type matters (covered in Unit 8) — dividends earned inside a Roth or Traditional retirement account aren't taxed the same way as dividends earned in a regular brokerage account.

Tax-loss harvesting explained

Tax-loss harvesting means deliberately selling an investment that's currently at a loss in order to "realize" that loss for tax purposes — which can offset gains elsewhere in your portfolio and reduce your overall tax bill. Many investors then reinvest the proceeds into a similar (but not identical) investment to stay in the market.

There are specific rules around this — notably the "wash sale rule," which disallows the tax benefit if you buy back a substantially identical investment within 30 days — so this strategy requires some care to execute correctly.

Why account type changes your tax bill

The exact same investment held in three different account types can produce three very different tax outcomes. In a Traditional 401(k)/IRA, growth is tax-deferred until withdrawal. In a Roth account, growth is entirely tax-free at withdrawal. In a regular taxable brokerage account, you owe tax on dividends every year they're paid and on capital gains whenever you sell.

This is why many experienced investors think carefully about "asset location" — not just what to invest in, but which account to hold each investment in, to minimize the total tax drag over time.

Key terms

Capital gain

The profit made when you sell an investment for more than you paid.

Short-term vs. long-term gain

Gains on investments held a year or less are short-term; held over a year, they qualify for lower long-term tax rates.

Qualified dividend

A dividend taxed at the lower long-term capital gains rate rather than ordinary income rates.

Tax-loss harvesting

Deliberately selling a losing investment to realize a loss that can offset taxable gains.

Wash sale rule

A rule disallowing a tax loss if a substantially identical investment is bought back within 30 days.

Asset location

Deciding which account type to hold each investment in to minimize total tax drag.