Image shows a picture of Lindsey Bell, Ally Invest’s chief markets & money strategist. The title reads “Meme Stocks & Tax Consequences”

Can you believe it’s been a year since the meme stock phenomenon took off?

Many newer investors dipped their toes into the trend to, well, make money. For most, it was a lot less about taking on Wall Street and more about building wealth. Specifically, meme stocks or cryptocurrencies were considered a way to increase income and improve portfolio performance regardless of investment size, according to a survey by Ally. Almost a quarter of Ally Invest’s customers participated in the meme craze, trading stocks like AMC, GameStop, Blackberry and Nokia.

Making money off trading these stocks was common, but it was just as common as losing money. Now, there are tax consequences.

Graph titled Making Money Tops Reasons for Meme Stock Trading shows Ally’s survey results: Earn extra income (50%), Higher portfolio returns (41%), My own research (34%), Advice on social platforms (29%), Advice from friends/relatives (27%) and Reddit forums (26%). Source: Ally

Millennials Trading

Meme stock mania hit its initial crescendo between January and February 2021. A secondary burst of excitement took place in June 2021. Volatile stocks — like GameStop and AMC — became posterchildren of the movement. Individuals were actively trading these types of stocks and cryptocurrencies, with more than 50% buying or selling on a weekly and monthly basis. It’s easy to play Monday morning quarterback when looking at the 12-month chart of these stocks, as most of the high-flying growth stocks of early 2021 have given back significant chunks of their gains. But timing of entries and exits is what matters for profits/losses … and for taxes.

Graph titled Frequent Trading in Meme Stocks Was Common tracks Ally survey results for frequency of buying and selling: Multiple times a day (2%), Daily (5%), Weekly (23%), Monthly (29%), Quarterly (22%), Once a year (8%), Less than once a year (6%), Never (2%). Source: Ally

At Ally, younger generations were more likely to buy and sell these stocks — 57% of 2021 meme stock trades were done by millennials followed by 29% of Gen Xers. Remarkably, today meme stock trading volume has nearly returned to the same level as Q4 2020 after quadrupling in Q1 2021 versus the prior quarter.

Investor Behavior

You’ve probably heard it before, but our natural biases can play a crucial role in making money or losing money in the stock market. Individuals are often susceptible to a bias known as “the disposition effect.” This mental quirk impacts many traders’ buying and selling patterns.

The disposition effect states that investors are more likely to quickly pull the sell trigger on a winning stock than a losing stock. In other words, while an investor will realize (or lock-in) gains, losses are likely to remain unrealized in the hopes of the stock reaching a higher price someday. Not surprisingly, given the move lower from the 52-week highs for several meme stocks, 82% of investors we surveyed said they still own one or more meme stock. It is quite possible they are sitting on unrealized losses.

For those that that did lock in their gains, Uncle Sam is likely to come knocking on their door to collect what is known as a capital gains tax. That is, unless the trades were made in a tax shielded type of account, like a 401k, IRA or HSA.

Knowing Capital Gains Rules

IRS form 1099-B contains short-term and long-term capital gain and loss information. For shares held one year or less, short-term capital gains rates apply — that’s usually your marginal income tax rate for the year. Long-term investors who harvest gains pay a more favorable rate — but you must hold securities for longer than one year to get that tax treatment.

Let’s say you were unsuccessful with some of your trades. It happens to the best of traders. The good news is a capital loss can offset a capital gain. Additionally, you can deduct up to $3,000 of total capital losses (if you sell your stock for a loss) from your taxable income. For example, if you are in the 22% marginal tax bracket, a $3,000 capital loss effectively puts $660 back in your pocket (or virtual wallet). A small saving grace, but it’s something.

Beware of Wash Sales

Another consideration for when you are selling a stock at a loss: make sure you are ready to walk away from the stock for more than 30 days. The tax benefit from selling at a loss can be tempting, but the IRS will be watching after you take that loss. A wash sale occurs when you buy a security in a taxable account, sell it for a loss, then purchase the same security or a “substantially identical” security within 30 days before or after the sale. Wash sales can ding your potential tax refund because the IRS’ rule prevents you from deducting it as a capital loss.

The Bottom Line

Meme stocks and cryptocurrencies helped engage several new investors over the past year. Some may have banked impressive profits, while others may not have been as lucky. If you were actively trading these or any other securities throughout the year, be aware of the tax consequences. Taxes can impact the total return of your portfolio and are an important consideration for any investing strategy.

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Expert Take with speech bubble icon

Headshot of Lindsey BellLindsey Bell, Ally’s chief markets & money strategist, is an award-winning investment professional with a passion for personal finance and more than 17 years of Wall Street experience. Bell’s unique ability to connect the dots between data and real life and craft bite-sized money ideas that people can use and apply stems from her deep background as an analyst, researcher and portfolio manager at organizations including J.P. Morgan and Deutsche Bank. She is known for demonstrating why and how an understanding of all things money improves a person’s finances and overall well-being. An ongoing CNBC contributor, Bell empowers consumers and investors across all walks of life and frequently shares her insights with the Wall Street Journal, Barron’s, Kiplinger’s, Forbes and Business Insider. She also serves on the board of Better Investing, a non-profit focused on investment education.

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