An investor makes money from an equity investment in three ways: selling shares for more than they cost, collecting dividends the company pays out of its profits, and, if the company is ever wound up, receiving a share of whatever assets are left after creditors are paid. The first is the most common and usually the largest source of return. The second provides income without selling. The third is a legal right that, in practice, rarely produces much.
Selling Shares for a Gain
The mechanic is simple. You buy shares at one price and sell them later at a higher price, and the difference is your profit. Buy 100 shares at $50 and sell them at $150, and you have made $100 a share, or $10,000. Until you sell, any increase is a paper gain. The profit becomes real, and taxable, only at the moment of sale.
Most sales happen through a brokerage, which routes the order to an exchange. Companies themselves sometimes buy shares back through repurchase programs, which reduces the number of shares outstanding and can lift the value of the ones that remain.
Cost Basis
Your cost basis is the number you subtract from the sale price to calculate the gain. It starts with what you paid, including commissions and fees, and adjusts for events like stock splits or reinvested dividends. For shares bought after 2010, your broker tracks the adjusted basis and reports it to the IRS on Form 1099-B.1Internal Revenue Service. Instructions for Form 1099-B Verify those figures yourself if shares moved between brokerages or came out of a merger or spinoff, where the basis allocation can be tricky.
When the Sale Produces a Loss
If you sell for less than your basis, you have a capital loss. Losses first offset gains from the same year. If losses exceed gains, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately), and anything left carries into future years.2Internal Revenue Service. Topic No. 409, Capital Gains and Losses
The wash sale rule blocks one common workaround. If you sell at a loss and buy the same or a substantially identical security within 30 days before or after that 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, so the tax benefit is deferred rather than lost outright.
How the Gain Is Taxed
Holding period drives the rate. Shares held for more than one year produce a long-term capital gain; a year or less makes it short-term.4Office of the Law Revision Counsel. 26 U.S. Code 1222 – Other Terms Relating to Capital Gains and Losses
Long-term gains are taxed at 0%, 15%, or 20% depending on taxable income and filing status. For 2026, single filers pay 0% up to $49,450, 15% above that, and 20% once taxable income passes $545,500. For joint filers, the 15% band begins above $98,900 and 20% above $613,700.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
Short-term gains get no break. They are taxed as ordinary income, running from 10% up to 37% for single filers earning above $640,600 in 2026.5Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 You report gains and losses on Schedule D of Form 1040 and detail individual transactions on Form 8949.6Internal Revenue Service. About Schedule D (Form 1040), Capital Gains and Losses
Collecting Dividends
Dividends are periodic cash payments a company distributes from its profits. They put money in your pocket without any need to sell. A company’s board decides whether to pay one, how much, and when, and the board can cut or skip a dividend when it wants to conserve cash. Dividends are never guaranteed.
What you own affects what you receive. Preferred stockholders generally have a contractual right to a set dividend rate before common shareholders receive anything.7Legal Information Institute. Preferred Stock Common shareholders only get paid if the board declares a dividend after preferred obligations are met, which makes preferred stock steadier on income and lighter on growth.
Many brokerages offer dividend reinvestment plans that automatically buy more shares with each payment. Reinvesting can accelerate compounding, but the tax treatment does not change. The IRS treats a reinvested dividend as if you took the cash, and your 1099-DIV reports the full amount either way.
Qualified Versus Ordinary Dividends
Qualified dividends are taxed at the same 0%, 15%, or 20% rates as long-term capital gains. To qualify, you generally need to hold the stock more than 60 days during the 121-day window that starts 60 days before the ex-dividend date.8Legal Information Institute. Definition: Qualified Dividend Income From 26 USC 1(h)(11) Most U.S. corporations and some foreign companies pay dividends that qualify once the holding rule is met.
Ordinary dividends are taxed at your regular income rate, up to 37% for the top bracket in 2026. Dividends from real estate investment trusts and money market funds typically fall into this category.
The Net Investment Income Tax
Higher earners owe an extra 3.8% surtax on investment income, including both capital gains and dividends. The Net Investment Income Tax applies once modified adjusted gross income passes $200,000 for single filers, $250,000 for joint filers, or $125,000 for married filing separately.9Internal Revenue Service. Topic No. 559, Net Investment Income Tax It is calculated on the lesser of your net investment income or the amount your income exceeds the threshold. These thresholds do not adjust for inflation, so more investors fall inside them over time.10Internal Revenue Service. Questions and Answers on the Net Investment Income Tax
With the surtax layered on, a top-bracket investor’s effective rate reaches 23.8% on long-term gains and qualified dividends and 40.8% on short-term gains and ordinary dividends. The NIIT is reported on Form 8960.
Residual Assets if the Company Is Liquidated
The third way equity pays off is the smallest and rarest. If a company shuts down and sells its assets, shareholders are entitled to whatever remains after every creditor is paid.
The order is set by the absolute priority rule. Secured creditors, who hold collateral against their claims, are paid first. Unsecured creditors, such as bondholders and suppliers, come next. Only once creditors are paid in full does anything reach equity holders, and preferred shareholders rank ahead of common shareholders inside that group.
Common shareholders often end up with nothing. A company with $1,000,000 in assets and $800,000 in debts leaves $200,000 for shareholders, and preferred holders take theirs before common holders see a cent. When liabilities exceed assets outright, which is common in bankruptcy, common equity is wiped out. This is the tradeoff at the heart of stock ownership: the largest upside through appreciation and dividends, the last position in line when things fail.
If Your Brokerage Fails
Company liquidation is not the same as brokerage failure, and it helps to keep them separate. When a company you own stock in goes under, the priority rule above governs what, if anything, you recover. When the brokerage holding your account fails, the Securities Investor Protection Corporation covers up to $500,000 per customer in securities and cash, with a $250,000 sublimit on cash.11SIPC. What SIPC Protects SIPC replaces missing securities and cash held by an insolvent broker. It does not reimburse market losses. A 50% drop in the price of a stock you own is not covered, no matter what caused it.