You are not taxed on growth, you are taxed on selling. Which makes the holding period, and how often you trade, more consequential than most people realise.
The account without a wrapper
Retirement accounts shelter growth. A regular brokerage account does not — you owe tax as you go and when you sell. In exchange there are no contribution limits, no early withdrawal penalties and no rules about when you can touch it.
It is the right account for money you may need before retirement, and it is where most people put savings once the tax-advantaged accounts are full. Understanding how it is taxed changes how you use it.
Long-term versus short-term is the big one
When you sell for a profit you owe capital gains tax, and the rate depends entirely on how long you held.
- Held one year or less — short-term. Taxed as ordinary income, at your normal bracket.
- Held more than one year — long-term. Taxed at preferential rates, which for many people are substantially lower, and for some are zero.
The gap is large enough that the holding date genuinely matters. Selling something eleven months in, when waiting five more weeks would reclassify the entire gain, is a common and expensive mistake.
You are not taxed on growth. You are taxed on selling — which is why doing less of it is a strategy.
Dividends have their own split
Qualified dividends get the long-term capital gains rates, provided holding period requirements are met. Ordinary dividends do not, and are taxed as income.
Either way, they are taxable in the year received even if automatically reinvested — which surprises people who never saw the cash. Bond fund income and interest are generally taxed as ordinary income too, which is why bonds are better held inside retirement accounts.
Cost basis: what you actually get taxed on
Your gain is the sale price minus your cost basis — what you paid, including reinvested dividends, which increase your basis.
Forgetting that reinvested dividends raise your basis means overstating your gain and overpaying tax. Brokerages track this now, but check it after transfers between firms, where basis information is frequently lost.
You can also choose which shares to sell. Specific identification lets you sell the highest-basis lots to minimise the gain, rather than accepting the default first-in-first-out. It is a setting, and most people never look at it.
Selling at a loss to claim it, then buying the same or a "substantially identical" security within 30 days before or after, disallows the loss. It applies across your accounts — including buying it back in an IRA, which permanently destroys the loss rather than deferring it. Automatic dividend reinvestment can trigger this accidentally.
Losses are useful
Capital losses offset capital gains. Beyond that, a limited amount of net loss can offset ordinary income each year, and anything further carries forward indefinitely.
Tax-loss harvesting means deliberately selling a position that is down to book the loss, then buying something similar but not identical to stay invested. Done carefully it lowers this year's tax without changing your allocation. Done carelessly it trips the wash sale rule.
Practical consequences
- Hold broad index funds here. They generate few internal capital gains distributions compared with actively managed funds, which can hand you a tax bill in a year you did nothing.
- Put bonds and high-income holdings in retirement accounts where their income is sheltered. Same overall allocation, lower tax.
- Turn off automatic reinvestment if you plan to harvest losses, or at least know it can conflict.
- Trade less. Every sale is a taxable event. The tax code rewards patience, which happens to align with what works anyway.
One point worth knowing for later: assets held at death have historically received a step-up in basis for heirs, which is a substantial argument against selling appreciated holdings late in life purely to rebalance.
This is educational content, not tax advice. Rates, thresholds and rules change; verify at irs.gov or with a professional.