Tax Consequences of Trading Stocks in an IRA Account

Tax Consequences of Trading Stocks in an IRA Account
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Individual retirement arrangements, also referred to as individual retirement accounts or IRAs, are tax-advantage investment accounts that allow taxpayers who have earned compensation to save toward their retirement. There are few restrictions on the types of investments you can purchase with funds in your IRA, including stocks. Unlike trading stocks in your traditional brokerage account, stock trades inside your individual retirement account involving the buying and selling of individual stocks in IRA plans do not result in a taxable event.

Comparing Types of IRAs

There are two primary types of individual retirement accounts; traditional IRAs and Roth IRAs. The primary differences between these two types of accounts involves how your funds are taxed going into the account and how they are taxed coming out of the account. You typically fund your traditional IRA with pre-tax dollars, while you can only fund your Roth IRA with after-tax dollars.

Qualified withdrawals from a traditional IRA are always taxed as ordinary income, while qualified withdrawals from your Roth IRA are free from federal income taxes. Funds inside both types of IRAs work the same. Any activity that occurs inside the account, including a stock trade, does not result in a currently taxable event. In other words, your investments in your IRA grow tax deferred until they are withdrawn.

Impact of Trading Stocks

There are a number of costs associated with trading stocks in your traditional brokerage account. You will typically pay a brokerage commission on each buy and sell order. If you sell your stock for more than you paid for it you will typically have a taxable IRS capital gains, which may be short term or long term depending on how long you owned your stock prior to the sale. If you sell your stock for less than you paid for it, you will typically have a capital loss that you can use to offset your capital gains when you file your federal income tax return.

Trading Stocks in IRAs

You can trade stocks inside your individual retirement account, whether you have a traditional IRA or a Roth IRA. You will still have to pay brokerage fees and commissions, but the stock trade inside your IRA will not result in a taxable event. You will not pay taxes on any gain that results from a trade, and you will not be able to reduce your taxable income by claiming any loss that results from a stock trade in your IRA.

All investment activity that occurs within your IRA is treated the same, regardless of the form it takes. Dividends, interest and capital gains are all allowed to grow without creating a current tax obligation.

Understanding IRA Withdrawals

All withdrawals from your traditional IRA are treated the same, regardless of how the funds were deposited or credited to your account. Withdrawals from your traditional IRA are always taxed as ordinary income in the year they are withdrawn at your then-current income tax rate. If you withdraw funds from your traditional IRA early, you may also be liable for a tax penalty of10 percent​ of the amount withdrawn. You can withdraw amounts equal to your contributions to your Roth individual retirement account at any time for any reason without paying income tax or a tax penalty, since you have already paid taxes on those funds.

You must allow any earnings produced by your stock trades and other investments to remain in your Roth IRA stock account for ​at least five years​ to qualify for tax-free withdrawal. You must typically be at least 59-1/2 years old before you can start taking qualified withdrawals from your Roth IRA.

All withdrawals of earnings from your Roth IRA are treated the same, regardless of whether they were created by stock trades, interest, dividends or some other form of income. Qualified withdrawals are always free from federal income taxes. Non-qualified withdrawals are always taxed as ordinary income and may be subject to a 10-percent tax penalty.

In 2020, the Coronavirus Aid, Relief, and Economic Security (CARES) Act temporarily removes the 10 percent penalty on early distributions, as long as the withdrawal is a Coronavirus-related distribution. There's an aggregate limit of ​$100,000​ from all plans and IRAs.

Reporting Requirements

You can use Form 5498 to report any IRA contributions to the IRS. This form must then be filed by your employer or the institution which manages your retirement account.