IRS Publication 550

IRS Publication 550: Investment Income And Expenses is the official tax playbook for anyone who earns money through stocks, bonds, mutual funds, or property sales, offering critical guidance on how to report capital gains, deduct investment expenses, and handle dividends on your federal tax return. If you’ve ever wondered how the Internal Revenue Service treats short-term vs. long-term gains, what counts as a wash sale, or how to navigate the rules for tax-exempt interest and bond premiums, this publication is your primary resource. While the document itself can be dense, understanding its core concepts—like cost basis, holding periods, and net investment income tax—is essential for lowering your tax bill and avoiding costly errors when filing Schedule D or Form 8949. In this article, we’ll unpack the key sections of IRS Pub 550, explain which forms you need for different types of investment income, and clarify the sometimes-tricky rules around investment interest expenses and non-deductible losses, so you can approach tax season with confidence rather than confusion.

What Is Investment Income?

Investment income isn’t just one thing; the IRS groups it into specific buckets that are taxed differently. Broadly, it covers interest, dividends, capital gains, and other earnings from property or assets you hold for profit.

The distinction matters because ordinary dividends are taxed at your regular income tax rate, while qualified dividends and long-term capital gains often benefit from lower tax rates (0%, 15%, or 20%). Publication 550 helps you sort your 1099 forms (like 1099-INT and 1099-DIV) into the right lines on your return.

Understanding Capital Gains And Losses

When you sell an asset for more than you paid, you have a capital gain. If you sell for less, it’s a capital loss.

The clock starts ticking the day after you buy an asset:

• Short-term: Held for one year or less (taxed as ordinary income).
• Long-term: Held for more than one year (taxed at preferential rates).

You report these transactions on Form 8949 and summarize them on Schedule D. A key benefit here is that capital losses can offset capital gains, and if your losses exceed your gains, you can deduct up to $3,000 of the excess loss against your other income (like wages).

The “Wash Sale” Rule Explained

One of the most common pitfalls for active traders is the wash sale rule.

If you sell a security at a loss and buy a “substantially identical” security within 30 days before or after the sale, the IRS disallows that loss for tax purposes. Instead of deducting the loss now, you must add it to the cost basis of the new stock, effectively pushing the tax benefit into the future. Publication 550 provides detailed examples of what counts as “substantially identical” so you don’t accidentally lose a deduction you were counting on.

Investment Expenses You Can (And Can’t) Deduct

Historically, investors could deduct certain miscellaneous itemized deductions for investment fees. However, under current tax law (post-Tax Cuts and Jobs Act), many of these deductions—like investment advisory fees—are suspended.

What is still deductible? Investment interest expense. If you borrow money to buy taxable investments (like buying stock on margin), the interest you pay is generally deductible up to the amount of your net investment income. You calculate this on Form 4952.

Tax-Exempt Interest And Municipal Bonds

Not all interest is created equal. Interest from bonds issued by state and local governments (municipal bonds) is generally free from federal income tax.

However, you still usually report it on your return (even if it’s not taxed) because it can affect other calculations, such as the taxability of your Social Security benefits. Publication 550 guides you on how to handle Original Issue Discount (OID) and bond premiums, ensuring you don’t overpay tax on complex bond instruments.

How To Report Crypto And Digital Assets

While Publication 550 is traditionally focused on stocks and bonds, its principles apply to cryptocurrency and other digital assets, which the IRS treats as property.

Selling crypto, exchanging one coin for another, or using crypto to buy goods triggers a capital gain or loss event. You must track your basis (what you paid) and your holding period just like you would for a share of stock. The wash sale rule’s application to crypto is a developing area, so keeping clean records is vital.

Net Investment Income Tax (NIIT)

Higher-income earners may face an extra 3.8% tax called the Net Investment Income Tax (NIIT). This applies if your modified adjusted gross income (MAGI) exceeds certain thresholds ($200,000 for single filers, $250,000 for married filing jointly).

NIIT applies to the lesser of your net investment income or the amount by which your MAGI exceeds the threshold. It’s an additional layer of tax that often catches successful investors by surprise.

Mutual Fund Distributions

Mutual funds can generate income even if you don’t sell a single share. Funds pass along their internal gains to shareholders as capital gain distributions.

You typically receive these at the end of the year, and they are reported on Form 1099-DIV. Importantly, long-term capital gain distributions are taxed at long-term rates, regardless of how long you have held the mutual fund shares.

Key Forms To Know

Filing taxes for investments involves a specific set of forms:

• Schedule B: For interest and ordinary dividends over $1,500.
• Schedule D: To summarize capital gains and losses.
• Form 8949: To list individual sales of assets.
• Form 4952: For investment interest expense deductions.
• Form 8960: For calculating Net Investment Income Tax.

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