Paying the Piper: Taxes on Investments

by David Jenyns on May 30, 2008

There is no question of an increase or loss in value of principal.

Does it affect principal or income? The federal income-tax rule is that when the seller has owned the stock for not more than six months, an increase in value is taxable income, and a loss is subtracted from income. (We omit some tax technicalities.)

Suppose a man paid $1,000 for stock, and ten years later he sold the same shares for $2,000, an increase of $1,000. For a stockholder, the federal tax rule says this distribution is a long-term gain, so that half of it is taxable income. Most of the investment companies pay a capital-gain dividend in the form of additional shares of stock, except when a stockholder asks for cash. 2. His future income dividends will be larger if he reinvests capital gains.

On an investment company’s capital-gain dividends, probably averaging for ten years is desirable.

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