Capital Gains and Losses – Chapter 21
“Capital” is usually dependent upon:
1. Whether it arises in a transaction involving a “capital asset”
2. Whether the capital asset has been the subject of a “sale or exchange”
3. How long the taxpayer has “held” the asset
*There are some statutes that may artificially accord capital gain or loss treatment to some transactions which do not actually involve the sale or exchange of a capital asset.
(1) Short-term capital gain – gain from the sale or exchange of a capital asset held for not more than 1 year
(2) Short-term capital loss – loss from the sale or exchange of a capital asset held for not more than 1 year
(3) Long-term capital gain – held for more than 1 year
(4) Long-term capital loss – held for more than 1 year
(5)-(8) Netting of short-term losses against short-term gains and long-term losses against long-term gains
STCG – STCL = Net short-term capital gain or loss (1222(5) and (6))
LTCG – LTCL = Net long-term capital gain or loss (1222(7) and (8))
Review numbers on page 691
Net gains can arise in three situations:
1. A net short-term gain in excess of a net long-term loss (taxed at ordinary income)
2. A net long-term gain in excess of a net short-term loss (net capital gain Section 1222(11))
3. A combination of a net short-term gain and a net long-term gain
Collectible LTCG rate = 28%
If there is a “net capital gain,” Section 1(h) comes into play.
Corporation v. Individual – Treatment of Capital Gains
- Corporations compute and net their capital gains like noncorporate taxpayers but no preferential tax treatment is provided to corporations.
- Gains – noncorporate taxpayer has the advantage because of the preferential rate
- Losses – noncorporate taxpayer can offset ordinary income up to $3,000; corporations can only deduct losses from the extent of their gains
- However, Corporations – for carryover it is ALWAYS a short-term capital loss regardless of its origin (back three years, forward five years)
- Individuals can only carry forward losses
The Mechanics of Capital Losses
Section 165 – primary code section that determines whether a loss is deductible
- Capital losses are generally deductible only from or against capital gains.
- Any capital loss balance remaining is carried forward into succeeding taxable years (retaining either LT or ST capital loss)
Restrictions on capital losses offsetting ordinary income
- 1211(b) limitation – capital losses are deductible only to the extent of capital gains plus, if such losses exceed such gains, an amount of ordinary income not to exceed the lower of $3,000 ($1,500 married individual filing separately) or the excess of such losses over such gains.
- 1212(b) Carryover– Capital losses not utilized in the year incurred are carried over into subsequent taxable years and treated as LT or ST losses, depending on their original character.
- If the sum under 1211(b) does not exceed $3,000 of excess losses over gains, there is no “net capital loss,” no carryover, and no need to use 1212(b)
Make the 1212(b)(2) computation first, before computing carryover losses under Section 1212(b)(1)
The amount of the carryover will be the amount of the net short-term and net long-term capital losses reduced by the $3,000 amount that wiped out ordinary income. The character of the loss (ST or LT) remains the same.
1212(b)(2) Constructive ST Capital Gain – If the taxpayer has both net ST and net LT capital losses, the net ST capital loss is used first and then the net LT capital loss to eliminate the 1211(b) $3,000 deduction from ordinary income.
LT Gain $400 ST gain $400
LT Loss $2,400 ST loss $2,000
Net LT Loss (2,000) Net ST loss (1,600)
LT gain $400 ST gain $3,400
LT Loss $2,400 ST loss $2,000
Net LT Loss (2,000) Net ST Gain 1,400
1212(b)(1)(B) – There is a $600 excess of the $2,000 net LT capital loss. This is treated as a LT capital loss in the succeeding year.
Capital Losses are reborn indefinitely in succeeding taxable years until finally utilized or until their demise at the taxpayer’s death.
This Federal Tax Outline is keyed to Fundamentals of Federal Income Taxation, 15 edition, Foundation Press.