Reporting gains and losses

06 Dec, 2015 TAX LAW 0

Chapter 16
Reporting gains and losses

Introduction

One of the best ways to save tax dollars is to generate long-term capital gains, i.e., profits you make from the sale of assets such as stocks, bonds, and real estate. While short-term capital gains are taxed at the same ordinary income tax rates as wages, self-employment income, interest, and nonqualified dividends, special lower tax rates are assessed on long-term capital gains. To qualify for long-term capital gains treatment, you must hold a capital asset for more than 1 year.

The tax benefit of generating long-term capital gains is substantial. The tax rate applied to long-term capital gains depends on your marginal tax bracket. Net long-term capital gains are taxed at a maximum rate of 20% for high income taxpayers who are otherwise in the 39.6% regular income tax bracket (i.e., taxable incomes over $406,750 for individual filers, $432,200 for heads of households, $457,600 married filing jointly, and $228,800 if married filing separately). Net long-term capital gains received by taxpayers in the 10% and 15% tax brackets are taxed at a zero rate. For all others (i.e., taxpayers in the 25%, 28%, 33%, or 35% tax brackets), net long-term capital gains are taxed at 15%. These lower rates apply to both the regular tax and the alternative minimum tax.

Your net capital gain equals net long-term capital gains less net short-term capital losses. On top of the above rates that apply to most long-term capital gains, higher rates apply for certain assets. A 28% rate applies to collectibles held for more than 12 months and to the portion of the gain from the sale of qualified small business stock that is includable in taxable income; a 25% rate applies to real estate gains to the extent of depreciation taken in prior years.

In addition to paying regular income tax or alternative minimum tax on capital gains, the 3.8% Net Investment Income Tax (NIIT) is assessed on unearned Net Investment Income (NII). NII includes both short- and long-term capital gains, other than gains attributable to an active trade or business conducted by a sole proprietor, partnership, or S corporation. For individuals, the NIIT is 3.8% of the lesser of: (1) “net investment income” or (2) the excess of modified adjusted gross income (MAGI) over $200,000 ($250,000 if married filing jointly or a qualifying widow(er) with dependent child; $125,000 if married filing separately).

The tax rate differences between ordinary income and long-term capital gains have a profound effect on tax planning and investment allocation. This chapter will provide you with examples of how the rules work. It also provides advice on year-end planning such as capital gain harvesting.

What’s New

50% Exclusion of Qualified Small Business Stock Capital Gains. 50% (60 percent for certain empowerment zone businesses) of the gain from the sale of certain qualified small business stock acquired at original issue after December 31, 2013, or before February 18, 2009, and held for more than five years is excluded from income.

Tax Breaks and Deductions You Can Use Checklist

Lower tax rate on long-term capital gains. Generally, the gain realized from the sale of a capital asset is treated as a long-term capital gain if the property has been held more than one year (i.e., at least one year and a day) as of the date it is sold. The top tax rate on long-term capital gains is 20%, while the top rate on short-term capital gains and ordinary income is 39.6%. Therefore, if compatible with your investment goals, you should try to generate long-term capital gains, rather than short-term capital gains or ordinary income. For more information, see Reporting Capital Gains and Losses, later.

Family Tax Planning Opportunity. Given the 0% capital gains rate for low-bracket taxpayers, if you have appreciated stock or other capital assets that you plan to sell, consider gifting the asset to your children who are over age 18. (Unearned income of younger children is generally taxed at the marginal rate of the child’s parents, as if the parents had received the income, rather than at the child’s lower rate. See chapter 32, Tax on investment income of certain children, for more information about the so-called “kiddie tax.”) To the extent their other taxable income would be taxed at a regular tax rate of less than 25% (i.e., for 2014, taxable income of no more than $36,900 for single returns), they can take advantage of the 0% rate for net capital gains. (For children under age 19, and children age 19–23 who are full-time students, the “kiddie tax” rules can cause the child’s income to be taxed at the parent’s higher tax rates.) Depending on the value of the asset gifted, there may be gift tax implications. The gift tax exemption is $14,000 per individual in 2014. See chapter 44, Estate and gift tax planning, for further information.

Specific identification of share lots or bonds sold. Being able to specifically identify share lots and/or bonds sold provides you with the greatest opportunity to manage the amount of a gain or loss generated, as well as whether that gain or loss is treated as long term or short term. For more information, see Determination of cost basis and holding period, later.

Sale of qualified small business stock (QSBS). If you hold qualified small business stock, it is important that you keep track of your holding period to ensure you meet the minimum five-year holding period before you sell the stock to generate the potential tax savings associated with the sale of QSBS as discussed in this chapter and in chapter 14, Sale of property.

S Corporation Built-In Gains Tax. For tax years beginning in 2014, no tax is imposed on the net recognized built-in gain of an S corporation after the 10th year in the recognition period.

Text intentionally omitted.

This chapter discusses how to report capital gains and losses from sales, exchanges, and other dispositions of investment property on Form 8949 and Schedule D (Form 1040). The discussion includes the following topics.

How to report short-term gains and losses.
How to report long-term gains and losses.
How to figure capital loss carryovers.
How to figure your tax on a net capital gain.

If you sell or otherwise dispose of property used in a trade or business or for the production of income, see Publication 544, Sales and Other Dispositions of Assets, before completing Schedule D (Form 1040).

Useful Items

You may want to see:

Publication

537 Installment Sales
544 Sales and Other Dispositions of Assets
550 Investment Income and Expenses

Form (and Instructions)

4797 Sales of Business Property
6252 Installment Sale Income
8582 Passive Activity Loss Limitations
8949 Sales and Other Dispositions of Capital Assets
Schedule D (Form 1040) Capital Gains and Losses

TAXALERT

Beginning in 2011, the IRS required brokers to report the adjusted cost basis in addition to the gross proceeds on the sale of “covered securities” and also to report whether the realized gain or loss is long term or short term. “Covered securities” are securities that are purchased or acquired on or after the following effective dates:

Equities. Equity securities are covered securities if they are purchased or acquired on or after January 1, 2011.

Mutual funds and dividend reinvestment plan (DRP) shares. These types of investments are covered if they are purchased or acquired on or after January 1, 2012.

Other specified securities. Basis reporting is required for sales of options and sales of what might be called “simple” debt securities acquired after 2013, and sales of more complex debt securities acquired after 2015. Sales of debt securities with an original term to maturity of one year or less are exempt from basis reporting. Simple debt instruments include:

Debt instruments with a single fixed rate of interest payable at least annually in cash
Debt instruments with two or more alternative payment schedules (such as would arise from put and call features) but no other contingencies
Demand debt instruments with a fixed yield to maturity.

Noncovered securities are those purchased or acquired before the effective dates.

EXPLANATION

In connection with the new basis reporting requirements that took effect in 2011, the IRS replaced Schedule D-1 with Form 8949 for reporting each sale and exchange of capital assets not reported on another form or schedule, gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit, and nonbusiness bad debts. When completing your tax returns, use a separate Form 8949 (Part I for short-term capital gains and losses and Part II for long-term capital gains and losses) for each of the following types of transactions:

Form 8949, Box A or Box D – Basis was reported on Form 1099-B and reported to the IRS (Form 1099-B box 3 is completed and box 6b is checked);
Form 8949, Box B or Box E – Basis was NOT reported to the IRS (Form 1099-B box 3 may or may not be blank and box 6a is checked);
Form 8949, Box C or Box F – Transaction was not reported on Form 1099-B.

You may use as many Forms 8949 as you need to report your transactions. The combined totals from all of your Forms 8949 flow to Schedule D and then to Form 1040.

Exception to reporting each transaction on a separate line. Instead of reporting each of your transactions on a separate line of Form 8949, you can report them on an attached statement containing all the same information as Form 8949 and in a similar format. Use as many attached statements as you need. Enter the combined totals from all of your attached statements on a Form 8949 with the appropriate box checked. For example, report on line 1 of Form 8949 with box D checked all long-term gains and losses from transactions your broker reported to you on a statement showing that the basis of the property sold was reported to the IRS. If you have statements from more than one broker, report the totals from each broker on a separate line.

Do not enter “available upon request” and summary totals in lieu of reporting the details of each transaction on Form(s) 8949 or attached statements.

E-file. If you e-file your return, but choose not to include your transactions on the electronic short-term capital gain (or loss) or long-term capital gain (or loss) records, you must attach Form 8949 (or a statement with the same information) to Form 8453, U.S. Individual Income Tax Transmittal for an IRS e-file Return, and mail the forms to the IRS. See chapter 45, Everything you need to know about e-filing, for additional information.

Reporting Capital Gains and Losses

Generally, report capital gains and losses on Form 8949. Complete Form 8949 before you complete line 1b, 2, 3, 8b, 9, or 10 of Schedule D (Form 1040).

Use Form 8949 to report:

The sale or exchange of a capital asset not reported on another form or schedule;
Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit; and
Nonbusiness bad debts.

Use Schedule D (Form 1040):

To figure the overall gain or loss from transactions reported on Form 8949;
To report a gain from Form 6252 or Part I of Form 4797;
To report a gain or loss from Form 4684, 6781, or 8824;
To report capital gain distributions not reported directly on Form 1040 or Form 1040A;
To report a capital loss carryover from the previous tax year to the current tax year;
To report your share of a gain or (loss) from a partnership, S corporation, estate, or trust;
To report transactions reported to you on a Form 1099-B (or substitute statement) showing basis was reported to the IRS and to which none of the Form 8949 adjustments or codes apply; and
To report undistributed long-term capital gains from Form 2439.

On Form 8949, enter all sales and exchanges of capital assets, including stocks, bonds, etc., and real estate (if not reported on Form 4684, 4797, 6252, 6781, 8824, or line 1a or 8a of Schedule D). Include these transactions even if you did not receive a Form 1099-B or 1099-S (or substitute statement) for the transaction. Report short-term gains or losses in Part I. Report long-term gains or losses in Part II. Use as many Forms 8949 as you need.

Exceptions to filing Form 8949 and Schedule D (Form 1040). There are certain situations where you may not have to file Form 8949 and/or Schedule D (Form 1040).

Exception 1. You do not have to file Form 8949 or Schedule D (Form 1040) if you have no capital losses and your only capital gains are capital gain distributions from Form(s) 1099-DIV, box 2a (or substitute statements). (If any Form(s) 1099-DIV (or substitute statements) you receive have an amount in box 2b (unrecaptured Section 1250 gain), box 2c (Section 1202 gain), or box 2d (collectibles (28%) gain), you do not qualify for this exception.) If you qualify for this exception, report your capital gain distributions directly on line 13 of Form 1040 (and check the box on line 13). Also use the Qualified Dividends and Capital Gain Tax Worksheet in the Form 1040 instructions to figure your tax. You can report your capital gain distributions on line 10 of Form 1040A, instead of on Form 1040, if none of the Forms 1099-DIV (or substitute statements) you received have an amount in box 2b, 2c, or 2d, and you do not have to file Form 1040.

Exception 2. You must file Schedule D (Form 1040), but generally do not have to file Form 8949, if Exception 1 does not apply and your only capital gains and losses are:

Capital gain distributions;
A capital loss carryover;
A gain from Form 2439 or 6252 or Part I of Form 4797;
A gain or loss from Form 4684, 6781, or 8824;
A gain or loss from a partnership, S corporation, estate, or trust; or
Gains and losses from transactions for which you received a Form 1099-B (or substitute statement) that shows the basis was reported to the IRS and for which you do not need to make any adjustments in column (g) of Form 8949 or enter any codes in column (f) of Form 8949.

Stock A: Unrealized short-term capital gain	$10,000
Stock B: Unrealized long-term capital loss	($13,000)
Stock C: Unrealized long-term capital gain	$15,000

Assume that Nancy sells all three stocks in 2014. Nancy will compute her net capital gain for the year as follows:

Net long-term capital gain	$2,000
Net short-term capital gain	$10,000
Total gains	$12,000

Nancy has a net capital gain of $12,000. Nancy will pay $400 of tax on her net long-term capital gain ($2,000 × 20%) and $3,960 on her short-term capital gains, which are taxed at her regular 39.6% rate ($10,000 × 39.6%). Thus, Nancy will pay a total tax of $4,360 ($400 + $3,960) on her capital gains. Additionally, assuming the 3.8% Net Investment Income Tax (NIIT) tax applies, Nancy will be subject to an additional tax of $456 ($12,000 × 3.8%).

Assume instead that Nancy sells stocks A and B in 2014, but waits until 2015 to sell stock C.

Nancy will have a net long-term capital loss of $3,000 for 2014 ($10,000 gain on stock A, less $13,000 loss on stock B). Nancy will be allowed to offset the $3,000 capital loss against her ordinary income, giving her a $1,188 tax saving for 2014.

Nancy will also have a $15,000 net long-term capital gain in 2015 from the sale of stock C. This will represent a net capital gain subject to the maximum 20% rate on net capital gains. Nancy will pay $3,000 of tax in 2015 on her net capital gain ($15,000 × 20%).

By using tax planning, Nancy’s total liability on her capital gains would be $1,812 ($3,000 for 2015, less $1,188 of tax savings in 2014). As compared to the $4,360 of tax liability without tax planning, Nancy has saved $2,548. Additionally, assuming the 3.8% NIIT applies to Nancy’s $15,000 net capital gain in 2015, she will be subject to an additional tax of $570 ($15,000 × 3.8%) in 2015. Nancy delayed the payment of the tax by waiting until 2015 to trigger some of her gains.

The tax savings to Nancy may be small relative to the investment ramifications of holding stock C for a longer period. Nancy must therefore balance the potential tax savings against her overall investment strategy.

EXPLANATION

A capital gain or loss results from (1) the sale or exchange of a capital asset or (2) net Section 1231 gains being treated as a capital gain.

Almost everything you own and use for personal or investment purposes is a capital asset. For example, stocks, bonds, artwork, jewelry, and household furnishings generally are all capital assets. Most properties held in a business (e.g., inventory, accounts receivable, machinery) are not capital assets. See chapter 14, Sale of property, for a further explanation on what constitutes a capital asset.

A net Section 1231 gain is also treated as a capital gain, while a net Section 1231 loss is treated as an ordinary loss. A Section 1231 gain or loss is any gain or loss from the sale or exchange of real property or depreciable personal property used in your trade or business and held by you for more than 1 year. Any depreciation recapture must be separately computed on the sale of depreciable property and reported as ordinary income. Thus, the portion of the gain that is considered depreciation recapture is ordinary income, rather than a Section 1231 gain. The computation of depreciation recapture is discussed in more detail at the end of this chapter.

Only gold members can continue reading. Log In or Register to continue

Fastest Law Search Engine