An investor makes money from an equity investment in three ways: selling shares for more than they paid, receiving dividend payments while they hold the shares, and collecting a share of what remains if the company is liquidated. The first is the main engine of returns for most investors, the second provides income without selling, and the third rarely produces anything at all. Each is taxed differently, and the rules matter as much as the gross return.
Selling Shares for More Than You Paid
The most common profit comes from price appreciation. You buy shares at one price, sell them later at a higher price, and keep the difference. Buy 100 shares at $50 and sell them at $150, and your profit is $100 per share, or $10,000 total.
That profit is only real once you sell. Any rise in value before then is a paper gain, and it carries no tax. The moment you sell, the gain becomes realized and reportable.
Cost Basis
Your cost basis is what you paid for the shares, including commissions and fees. Stock splits and reinvested dividends adjust it. When you sell, subtract your adjusted basis from the sale price to get your gain or loss.
For shares bought after 2010, your brokerage tracks basis and reports it to the IRS on Form 1099-B.1Internal Revenue Service. Instructions for Form 1099-B Verify the figures yourself if you transferred shares between brokerages or received shares through a merger or spinoff, where basis allocation gets complicated.
When the Sale Produces a Loss
If you sell for less than your basis, you have a capital loss. Losses first offset any capital gains realized the same year. If losses exceed gains, you can deduct up to $3,000 of the remainder against ordinary income ($1,500 if married filing separately), and anything beyond that carries forward to future years.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses
One restriction trips up many investors. Under the wash sale rule, if you sell at a loss and buy the same or a substantially identical security within 30 days before or after the sale, the IRS disallows the loss.3Office of the Law Revision Counsel. 26 U.S. Code 1091 – Loss From Wash Sales of Stock or Securities The disallowed amount is added to the basis of the replacement shares, deferring the tax benefit until you later sell those shares in a clean transaction.
How Your Sale Profits Are Taxed
The IRS classifies profit from selling equity as a capital gain, and the rate depends on how long you held the shares.4Office of the Law Revision Counsel. 26 USC 1221 – Capital Asset Defined The dividing line is one year. Held more than a year, the gain is long-term.5Office of the Law Revision Counsel. 26 U.S. Code 1222 – Other Terms Relating to Capital Gains and Losses Held a year or less, it’s short-term.
Long-term gains are taxed at 0%, 15%, or 20%, depending on taxable income and filing status. For 2026, single filers pay 0% on long-term gains if taxable income is $49,450 or less, 15% in the range above that, and 20% once taxable income passes $545,500. For married couples filing jointly, the 15% rate starts above $98,900 and the 20% rate above $613,700.6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Short-term gains get no preferential rate. They are taxed as ordinary income, which for 2026 runs from 10% up to a top rate of 37% for single filers earning above $640,600.6Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Holding past the one-year mark before selling can meaningfully cut your tax bill. Capital gains and losses go on Schedule D of Form 1040, with individual transactions on Form 8949.7Internal Revenue Service. About Schedule D (Form 1040), Capital Gains and Losses
Earning Dividends While You Hold
Dividends are periodic cash payments a company distributes from its profits. They provide income without requiring you to sell. A company’s board of directors decides whether to pay a dividend, how much, and when. Dividends are never guaranteed, and a board can cut or skip them if the company needs to preserve cash.
The kind of stock you own matters. Preferred stockholders generally have a contractual right to dividends at a set rate before common stockholders get anything.8Legal Information Institute. Preferred Stock Common stockholders receive dividends only if the board declares them after preferred obligations are met.
Who Gets Paid, and When
Four dates control the dividend process:
- Declaration date: the board announces the dividend and sets the other dates.
- Record date: you must be a registered shareholder on this date to receive payment.
- Ex-dividend date: typically the same day as the record date under current settlement rules. Buy shares on or after this date and the seller, not you, gets the upcoming dividend.9U.S. Securities and Exchange Commission. Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends
- Payment date: the company sends the cash to eligible shareholders.
To receive a dividend, buy before the ex-dividend date.
Reinvesting Dividends
Many brokerages offer dividend reinvestment plans (DRIPs) that use your dividend payments to buy more shares automatically. Compounding builds faster, but a tax detail catches investors off guard: reinvested dividends are still taxable income the year they are paid. The IRS treats the payment as if you received cash, and your brokerage reports the full amount on your 1099-DIV whether you took the cash or not.
How Dividends Are Taxed
Dividends fall into two tax categories. Qualified dividends get the same preferential rates as long-term capital gains: 0%, 15%, or 20%. To qualify, you generally must hold the stock for more than 60 days during the 121-day window that begins 60 days before the ex-dividend date.10Legal Information Institute. Definition: Qualified Dividend Income From 26 USC 1(h)(11) Dividends from most U.S. corporations and certain foreign companies qualify when the holding period is met.
Ordinary (non-qualified) dividends are taxed at your regular income tax rate, up to 37% in 2026. Dividends from real estate investment trusts (REITs) and money market funds typically fall into this category.
Dividends from foreign companies may be subject to withholding tax by the foreign country. You can usually claim a foreign tax credit on your U.S. return to avoid being taxed twice. If total foreign taxes paid are $300 or less ($600 for married filing jointly), you can claim the credit directly without filing the separate Form 1116.11Internal Revenue Service. Instructions for Form 1116 (2025)
The 3.8% Surtax on Investment Income
Higher-income investors face an additional 3.8% Net Investment Income Tax (NIIT) on both capital gains and dividends. It applies when modified adjusted gross income exceeds $200,000 for single filers, $250,000 for married couples filing jointly, or $125,000 for married people filing separately.12Internal Revenue Service. Topic No. 559, Net Investment Income Tax The tax is calculated on the lesser of your net investment income or the amount by which your income exceeds the threshold.
Investment income for this purpose includes gains from selling stock, capital gain distributions from mutual funds, and dividends.13Internal Revenue Service. Questions and Answers on the Net Investment Income Tax Wages, Social Security benefits, and self-employment income are excluded. These thresholds are not indexed to inflation, so more investors become subject to the NIIT over time.
In practice, the surtax pushes a high-income investor’s top effective rate on long-term capital gains to 23.8%, and on short-term gains to 40.8%. The NIIT is reported on Form 8960.
What You Get if the Company Liquidates
The third source of return is the rarest: if a company dissolves, equity holders are entitled to a share of whatever assets remain after debts are paid.
Payment follows the absolute priority rule. Secured creditors get paid first. Unsecured creditors like bondholders and suppliers come next. Only after every creditor is fully repaid do equity holders receive anything, and among equity holders, preferred shareholders rank above common shareholders.
Common stockholders often receive nothing. If a company’s assets are worth $1,000,000 and its debts total $800,000, only $200,000 remains for equity holders, and preferred shareholders take their share first. In many bankruptcies, liabilities exceed assets entirely and equity is wiped out. This is the tradeoff built into equity: the highest potential upside through appreciation and dividends, and the last position in line if things fail.
Brokerage Failure Is a Separate Issue
Company liquidation is not the same as brokerage failure. If the company whose stock you own goes bankrupt, the priority rules above decide what you receive. If your brokerage firm itself becomes insolvent, the Securities Investor Protection Corporation (SIPC) steps in and covers up to $500,000 in securities and cash per customer, with a $250,000 limit on the cash portion.14SIPC. What SIPC Protects
SIPC protects the return of your securities when a member brokerage fails. It does not cover a decline in the value of your investments. If your shares fall 50% in a market selloff, SIPC does nothing. It only acts when the brokerage can no longer return the securities or cash it was holding for you.