Individual retirement accounts (IRAs) provide taxpayers who have earned compensation, such as salaries, wages, tips, commissions and bonuses, with a means of setting aside a portion of those earnings in a tax-advantaged account toward their retirement years. There are two basic types of individual retirement accounts: traditional IRAs and Roth IRAs. Each type of IRA offers significant, though different, tax advantages, but both types allow investments inside the account to grow without incurring a current income tax obligation.
The Internal Revenue Service considers almost everything you own for either investment purposes or personal use to be a capital asset. Personal capital assets may include your home, your car, your laptop computer and your lawn mower. Investment capital assets may include any stocks or bonds you own, rental property and funds in your 401(k) at work. Investment capital assets may also include investments in your individual retirement account.
You may experience either a capital gain or a capital loss when you sell a capital asset. If you sell a capital asset for more than you paid for it, you typically have a capital gain. If you sell a capital asset for less than you paid for it, you typically have a capital loss. The Internal Revenue Service considers all capital gains to be income, which you must report when you file your federal income tax report, regardless of whether the capital gain resulted from the sale of a personal or investment asset.
Long-Term vs. Short-Term
The Internal Revenue Service considers any gain from the sale of a capital asset that you held for one year or less to be a short-term capital gain, while gains on capital assets that you held for longer than one year are considered long-term capital gains. The income tax rate on long-term capital gains is typically lower than the income tax rate on short-term capital gains as of the 2010 tax year, according to the Internal Revenue Service.
Exceptions for Capital Assets in an IRA
Capital assets held in an individual retirement account are allowed to grow tax-deferred as long as the assets remain in the IRA, regardless of whether the account is a traditional IRA or a Roth IRA. All income produced by the capital assets in an IRA are treated the same for income tax purposes, regardless of whether the income resulted from interest, dividends, long-term capital gains, short-term capital gains or tax-free payments from a municipal bond. All withdrawals from a traditional IRA are taxed as ordinary income, regardless of the type of gain that occurred inside the IRA. Qualified withdrawals of all gains produced in Roth IRA are free from federal income taxes, regardless of the type of gain. Nonqualified withdrawals of all gains produced in a Roth IRA are taxed as ordinary income and may be subject to a 10-percent income tax penalty.
- IRS.gov: Publication 590, Traditional IRAs
- IRS.gov: Publication 590, Roth IRAs
- Fairmark; Basic Questions About Capital Gains and Losses; Kaye A. Thomas
- Internal Revenue Service. "Topic No. 409 Capital Gains and Losses." Accessed Nov. 4, 2020.
- Internal Revenue Service. "2019 Publication 550." Accessed Nov. 4, 2020.
- Internal Revenue Service. "IRS Provides Tax Inflation Adjustments for Tax Year 2020." Accessed Nov. 4, 2020.
- Internal Revenue Service. "2019 Publication 523." Accessed Nov. 4, 2020.
- Internal Revenue Service. "Questions and Answers on the Net Investment Income Tax." Accessed Nov. 4, 2020.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.