Reddit has been thrust into the spotlight in recent weeks as an unlikely source of stock advice. The site made headlines when a group of users from a sub-forum called r/WallStreetBets got together and orchestrated a short-squeeze on GameStop (NYSE:GME) that cost hedge funds billions. But that's not the only trading advice people share on the site.
Now, ideally, you won't be selecting your investments solely based on advice from Reddit (or from any other random internet forums). That's because you'll want to develop your own informed investment strategy and be careful about where you obtain financial information that helps you do that.
That doesn't mean you won't ever make money from Reddit stocks. And if you do happen to earn a profit from investments you heard about on the site, you'll need to understand the taxes you could owe.
What taxes will you owe on Reddit stocks?
The rules for taxes on stocks always work the same way, regardless of whether you purchased shares because you heard about them on an internet forum or made your investment choice via other means. You'll pay taxes when you sell your stocks at a profit, and only if they're not in a tax-deferred account such as an IRA. And you'll be taxed:
- At your ordinary income tax rate for short-term capital gains. This rate applies if you own the stock for a year or less.
- At the long-term capital gains tax rate, which is between 0% and 20% depending on your income. This rate applies if you own the stock for more than a year.
The long-term capital gains rate is generally much lower than the rate you'd pay on short-term gains. That's one of many reasons buying and holding stocks for the long term (rather than day-trading meme stocks) is generally the smarter financial move.
You can offset your gains with losses
Chances are, not every Reddit stock you invest in will be a winner. The good news is, if you sell a stock at a loss, you can claim a deduction for capital losses.
You can offset an unlimited amount of capital gains with losses. So, for example, if you made a $10,000 profit on one of your Reddit stocks but lost $20,000 on another, you'd be able to offset your entire profit by declaring $10,000 in losses and wouldn't owe any taxes on your gains. However, when you claim the deduction, you have to offset short-term gains first against short-term losses and long-term gains against long-term losses.
If it turns out you lost more money than you made, you're also allowed to deduct up to $3,000 in capital losses against other income types. That means you could claim those losses against your wages from your job and reduce your taxable income by up to $3,000.
And if you still have more capital losses, you can carry them over from year to year. So if you end up making a profit next year, you'd be able to use the losses you incurred this year to offset it and avoid being taxed on it.
Prepare for a tax bill if you made a profit on Reddit stocks
It's important to declare all your investment income and make sure you're prepared to pay taxes on it by the tax deadline for the year in which the income was earned. So if you made a profit on your Reddit stock, make sure you have money set aside to give the IRS a cut.