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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 $418,400 for individual filers, $444,550 for heads of households, $470,700 for married filing jointly, and $235,350 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 maximum 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 includible 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.

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 1 year (i.e., at least 1 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 “kiddie tax.”) To the extent their other taxable income would be taxed at a regular tax rate of less than 25% (i.e., for 2017, taxable income of no more than $37,950 for single returns), they can take advantage of the 0% rate for net capital gains. (For children under age 19, and children ages 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 2017. See chapter 45, 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 5-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.

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 Pub. 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)

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

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 1 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, Sales and Other Dispositions of Capital Assets, 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 46, 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.
Worthlessness of a security.

Use Schedule D (Form 1040) to report:

Overall gain or loss from transactions reported on Form 8949;
Certain transactions you do not have to report on Form 8949;
Gain from Form 2439 or 6252 or Part I of Form 4797;
Gain or loss from Form 4684, 6781, or 8824;
Gain or loss from a partnership, S corporation, estate, or trust;
Capital gain distributions not reported directly on your Form 1040; and
Capital loss carryover from the previous year to the current year.

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, Form 1040). Include these transactions even if you did not receive a Form 1099-B or 1099-S 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. If any Form(s) 1099-DIV 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 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 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.

EXPLANATION

Characterizing your gain or loss. When you sell or dispose of property, you must determine whether your gain or loss is capital or ordinary. Only capital gains and capital losses are reported on Form 8949 and Schedule D, while ordinary gains and losses are reported elsewhere. This distinction is significant because (1) you can use capital losses to offset gains only to the extent of capital gains plus $3,000 and (2) net capital gains may be subject to a lower tax rate than ordinary income. Any unused capital losses can be carried over to the next year.

Example

Assume that Alan is married filing a joint return and has $12,000 of capital losses and $4,000 of capital gains in 2017. Alan can deduct only $7,000 of his capital losses in 2016, which is equal to his $4,000 of capital gains plus $3,000. The remaining $5,000 of losses ($12,000 gross losses minus $7,000 of losses used) may be carried over and used in later years, subject to the $3,000 limitation. If Alan’s filing status was married filing separately, his capital loss limitation would be $1,500 instead of $3,000. If Alan’s losses were ordinary, he could have used all of them in 2017 unless subject to other limitations by special provisions of the Internal Revenue Code.

EXPLANATION

Determining your capital gains rate. The capital gains rate depends on the type of property sold, the holding period prior to sale, and your overall income level. Short-term capital gains are subject to ordinary income rates. Net capital gains are the excess of: (1) net long-term capital gains, over (2) net short-term capital losses.

For 2017, the top marginal ordinary income tax rate—which applies to short-term capital gains—is 39.6%. This rate applies to taxpayers with taxable incomes over $418,400 for individual filers, $444,550 for heads of households, $470,700 married filing jointly, and $235,350 for married filing separately. The top rate on net capital gains (defined as the excess of net long-term capital gains over net short-term capital losses) is 20% for high-income taxpayers who are otherwise in the 39.6% regular income tax bracket. Net capital gains received by taxpayers in the 10% and 15% tax brackets are not subject to federal income tax; i.e., they are taxed at a 0% rate. For taxpayers in the 25%, 28%, 33%, or 35% tax brackets, net capital gains are taxed at 15%. These lower rates on net capital gains apply to both the regular tax and the alternative minimum tax.

You can achieve substantial tax savings by generating long-term capital gains in lieu of short-term capital gains or ordinary income, to which applicable ordinary tax rates are generally greater.

(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). These threshold dollar amounts are not indexed each year for inflation. For more information, see Net Investment Income Tax, later.)

Example

Erik bought 3,000 shares of ABC Company on June 1, 2016, when the price of the stock was $20 per share. On July 1, 2017, he sold all of his ABC holdings for $25 per share, realizing a profit of $15,000. Erik files a joint return with his wife showing a combined taxable income that places him in the 39.6% tax bracket. Because he held the ABC stock for more than 12 months, Erik is eligible for the favorable capital gain tax rates. As a 39.6% taxpayer, his long-term capital gain on ABC stock would be taxed at 20%. (This example does not consider the calculation of the 3.8% Net Investment Income Tax that applies to higher income taxpayers.)

TAXPLANNER

Long-term capital gains vs. ordinary income. The difference between the top marginal rate on ordinary taxable income, including short-term capital gains of 39.6% and the top rate on net capital gains of 20%, is significant—a 19.6% difference. Since the long-term capital gain rate is much lower than ordinary rates, you should try to generate long-term capital gains whenever possible. It should be noted, however, that the tax law recharacterizes gains from certain conversion transactions into ordinary income. See later in this chapter for an explanation of conversion transactions.

Example

Nancy is in the 39.6% marginal tax bracket for 2017 and has the following unrealized capital gains and losses:

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 2017. 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 2017, has no other investment income for 2017, and waits until 2018 to sell stock C.

Nancy will have a net long-term capital loss of $3,000 for 2017 ($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 2017.

Nancy will also have a $15,000 net long-term capital gain in 2018 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 2018 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 2018, less $1,188 of tax savings in 2017). As compared to the $4,360 of tax liability without tax planning, Nancy has saved $2,548. Nancy delayed the payment of the tax by waiting until 2018 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.

Section 1231 gains also include recognized gains on the involuntary conversion of (1) property used in a trade or a business and held for more than 1 year, and (2) any capital asset held for more than 1 year and held in connection with a trade or a business or a transaction entered into for profit. Net involuntary conversion losses on these properties are not Section 1231 losses, and instead are deductible as ordinary losses. An involuntary conversion is the loss of property resulting from destruction (complete or partial), theft, seizure, requisition, or condemnation. An involuntary conversion also includes the sale or exchange of property under the threat or imminence of seizure, requisition, or condemnation.

For more information, see Publication 544, Sales and Other Dispositions of Assets.

Tax treatment of gains and losses. Once the disposition is properly classified, you can determine whether your gains and losses will be considered ordinary, capital, or, in the case of losses, nondeductible.

Losses on the sale of personal-use property (e.g., a family car, jewelry) cannot be used to offset capital gains and are not reported on your income tax return. Capital gains on the sale of personal-use property are taxable and should be reported on Form 8949.

You must aggregate all your Section 1231 gains and losses during the year to determine the tax treatment of these items. Net Section 1231 gains are treated as capital, while net Section 1231 losses are treated as ordinary. Under a special look-back rule, if you have a net Section 1231 gain in 2017 the gain will be treated as ordinary income to the extent of any Section 1231 losses in the preceding 5 years (which were not previously used to recharacterize gains). Remember, any gain resulting in depreciation recapture is ordinary income and as a result is not considered in these computations. You should fill out Form 4797, Sales of Business Property, to report these items. Ordinary gains and losses are generally reported separately on Form 1040 when arriving at adjusted gross income, while capital gains are reported on Schedule D.

TAXALERT

The Section 1231 gain recharacterization applies to Section 1231 gains and losses from all sources. In other words, the Section 1231 gain and Section 1231 loss in a preceding year do not need to be from the same source to be subject to recharacterization. For example, if you reported a Section 1231 loss from a partnership interest in 2016 and a Section 1231 gain from your rental property in 2017, the Section 1231 gain will be recharacterized due to the Section 1231 loss from the partnership in a prior year.

Capital gains and losses reported on Schedule D and Form 8949 are further classified under long-term and short-term. Net Section 1231 gains are long-term. For other classifications, see the discussion in chapter 14, Sale of property. For the limitation of Section 1231 losses that are classified as passive losses, see Passive activity gains and losses, later.

TAXALERT

Recharacterizing capital gains. The Internal Revenue Code contains a provision that recharacterizes capital gains from certain conversion transactions as ordinary income. The purpose of this provision is to prohibit taxpayers from taking advantage of the favorable tax rate on capital gains by entering into transactions that are in effect loans, but because of their form generate capital gains. In a conversion transaction, the taxpayer is in the economic position of a lender and substantially all of the taxpayer’s return is attributable to the amount of time the investment is held. A transaction will be treated as a conversion transaction if it contains at least one of the following four elements: (1) the transaction consists of the acquisition of property by the taxpayer and a substantially contemporaneous agreement to sell the same or substantially identical property in the future; (2) the transaction is a straddle (see chapter 14, Sale of property); (3) the transaction is one that is marketed or sold to the taxpayer on the basis that it would have the economic characteristics of a loan, but the interest-like return would be taxed as capital gain; or (4) the transaction is described in regulations promulgated by the Secretary of the Treasury.

Installment sales. You cannot use the installment method to report a gain from the sale of stock or securities traded on an established securities market. You must report the entire gain in the year of sale (the year in which the trade date occurs).

Passive activity gains and losses. If you have gains or losses from a passive activity, you may also have to report them on Form 8582. In some cases, the loss may be limited under the passive activity rules. Refer to Form 8582 and its instructions for more information about reporting capital gains and losses from a passive activity.

Form 1099-B transactions. If you sold property, such as stocks, bonds, or certain commodities, through a broker, you should receive Form 1099-B from the broker. Use the Form 1099-B to complete Form 8949 and/or Schedule D (Form 1040).

If you received a Form 1099-B for a transaction, you usually report the transaction on Form 8949. Report the proceeds shown in box 1d of Form 1099-B in column (d) of either Part I or Part II of Form 8949, whichever applies. Include in column (g) any selling expenses or option premiums not reflected in Form 1099-B, box 1d or box 1e. If you include a selling expense in column (g), enter “E” in column (f). Enter the basis shown in box 1e in column (e). If the basis shown on Form 1099-B is not correct, see How To Complete Form 8949, columns (f) and (g) in the Instructions for Form 8949 for the adjustment you must make. If no basis is shown on Form 1099-B, enter the correct basis of the property in column (e). See the Instructions for Form 1099-B, Form 8949, and Schedule D (Form 1040) for more information.

EXPLANATION

Form 1099-B typically will only include cost basis information in box 1e if the securities sold are covered securities. In 2017, the term “covered securities” includes equity securities that were purchased or acquired on or after January 1, 2011, mutual funds and dividend reinvestment plan (DRP) shares that were purchased or acquired on or after January 1, 2012, and other securities, including certain debt instruments and options that were purchased or acquired on or after January 1, 2014. More complex debt securities will not become covered securities for broker cost basis reporting purposes until on or after January 1, 2016. Include the amount reported in box 1e on Form 8949, column I, and check box (A) if Short-Term, (D) if Long-Term. If Form 1099-B, box 1e, is blank, you should complete column I with the appropriate cost basis from your records and check box (B) if Short-Term, (E) if Long-Term on the Form 8949. Since the implementation of the new basis reporting rules is rolled out over five years beginning in 2011 and will be fully implemented in 2016, you may receive multiple Forms 1099-B from the broker for the same account. Make sure to examine all Forms 1099-B carefully to ensure all transactions are reported on Form 8949.

Form 1099-CAP transactions. If a corporation in which you own stock has had a change in control or a substantial change in capital structure, you should receive Form 1099-CAP from the corporation. Use the Form 1099-CAP to fill in Form 8949. If your computations show that you would have a loss because of the change, do not enter any amounts on Form 8949 or Schedule D (Form 1040). You cannot claim a loss on Schedule D (Form 1040) as a result of this transaction.

Report the aggregate amount received shown in box 2 of Form 1099-CAP as the sales price in column (d) of either Part I or Part II of Form 8949, whichever applies.

Form 1099-S transactions. If you sold or traded land (including air rights), a building or similar structure, a condominium unit, or co-op stock, you may receive a Form 1099-S, Proceeds From Real Estate Transactions, showing your proceeds and other important information.

See the Instructions for Form 8949 and the Instructions for Schedule D (Form 1040) for how to report these transactions and include them in Part I or Part II of Form 8949 as appropriate. However, report like-kind exchanges on Form 8824 instead.

See Form 1099-S and the Instructions for Form 1099-S for more information.

TAXORGANIZER

Documents you need to complete Form(s) 8949 and Schedule D. Taxpayers who sell stocks, bonds, or other property through a broker should maintain the following documentation in order to facilitate the completion of Form(s) 8949 and Schedule D:

Confirmations received from the broker documenting all sales transactions executed. You can use these to ensure the accuracy of any Forms 1099-B received.
Confirmations received from the broker documenting all purchase transactions executed. You may need these to calculate any gains or losses realized upon the sale of the property and to determine if you have long-term or short-term gains and losses to the extent the broker is not yet required to report the cost basis on Form 1099-B for the particular property you sold. Alternatively, if your broker reports the cost basis on your Form 1099-B, the purchase confirmation ensures the accuracy of the purchase price and date of acquisition.

Nominees. If you receive gross proceeds as a nominee (that is, the gross proceeds are in your name but actually belong to someone else), see the Instructions for Form 8949 for how to report these amounts on Form 8949.

File Form 1099-B or Form 1099-S with the IRS. If you received gross proceeds as a nominee in 2017, you must file a Form 1099-B or Form 1099-S for those proceeds with the IRS. Send the Form 1099-B or Form 1099-S with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns, to your Internal Revenue Service Center by February 28, 2018 (April 2, 2018, if you file Form 1099-B or Form 1099-S electronically). Give the actual owner of the proceeds Copy B of the Form 1099-B or Form 1099-S by February 15, 2018. On Form 1099-B, you should be listed as the “Payer.” The actual owner should be listed as the “Recipient.” On Form 1099-S, you should be listed as the “Filer.” The actual owner should be listed as the “Transferor.” You do not have to file a Form 1099-B or Form 1099-S to show proceeds for your spouse. For more information about the reporting requirements and the penalties for failure to file (or furnish) certain information returns, see the General Instructions for Certain Information Returns. If you are filing electronically, see Pub. 1220.

Sale of property bought at various times. If you sell a block of stock or other property that you bought at various times, report the short-term gain or loss from the sale on one row in Part I of Form 8949, and the long-term gain or loss on one row in Part II of Form 8949. Write “Various” in column (b) for the “Date acquired.”

Sale expenses. On Form 8949, include in column (g) any expense of sale, such as broker’s fees, commissions, state and local transfer taxes, and option premiums, unless you reported the net sales price in column (d). If you include an expense of sale in column (g), enter “E” in column (f).

For information about adjustments to basis, see chapter 13.

Short-term gains and losses. Capital gain or loss on the sale or trade of investment property held 1 year or less is a short-term capital gain or loss. You report it in Part I of Form 8949.

You combine your share of short-term capital gain or loss from partnerships, S corporations, estates, and trusts, and any short-term capital loss carryover, with your other short-term capital gains and losses to figure your net short-term capital gain or loss on line 7 of Schedule D (Form 1040).

Long-term gains and losses. A capital gain or loss on the sale or trade of investment property held more than 1 year is a long-term capital gain or loss. You report it in Part II of Form 8949.

EXPLANATION

The shortest length of time that qualifies for long-term status is 1 year plus 1 day. To calculate this period, your holding period begins on the day after you buy the property and includes the day you sell it.

Example

Donald pays $1,000 for Corporation X stock on August 3, 2016. His holding period begins on August 4, 2016. Donald sells the stock on August 3, 2017, for $1,500. His holding period runs from August 4, 2016 (the day after he purchased the stock), through August 3, 2017 (the day he sold the stock). Donald has a short-term capital gain of $500 because he has held the stock for exactly 1 year.

Assume instead that Donald sells the stock on August 4, 2017. His holding period runs from August 4, 2016, through August 4, 2017. His holding period is now in excess of 1 year (1 year and 1 day), so Donald’s gain will be long-term.

You report the following in Part II of Schedule D (Form 1040):

Undistributed long-term capital gains from a mutual fund (or other regulated investment company) or real estate investment trust (REIT);
Your share of long-term capital gains or losses from partnerships, S corporations, estates, and trusts;
All capital gain distributions from mutual funds and REITs not reported directly on line 10 of Form 1040A or line 13 of Form 1040; and
Long-term capital loss carryovers.

The result after combining these items with your other long-term capital gains and losses is your net long-term capital gain or loss (Schedule D (Form 1040), line 15).

EXPLANATION

Dividends from mutual funds, which are technically known as regulated investment companies, are frequently composed of a combination of long-term capital gains and ordinary income. The nature of the gain is determined by how long the mutual fund has held the underlying property that generates the income, not how long you have held the mutual fund shares. Consequently, you may realize a long-term capital gain, although you have held the mutual fund shares for less than the required long-term holding period.

Determination of cost basis and holding period. Mutual fund shares may be acquired on various dates, in various quantities, and at various prices. Some individuals may purchase shares through participation in a dividend reinvestment plan or a payroll deduction plan. Shares may also be sold on a periodic basis. As a result, individuals often encounter difficulty in determining their cost basis and gain or loss on the sale of their mutual fund shares. Mutual fund shareholders have three options for determining the cost basis of their shares. They are as follows:

The specific identification method.
The FIFO (first in, first out) method.
The single-category method using the average approach.

Effective April 1, 2011, the IRS eliminated a fourth category, which was the double-category method. If you used the double-category method for shares you acquired before and sold after April 1, 2011, the average basis of your shares is calculated by averaging together all identical shares in the account on April 1, 2011.

The specific identification method. In order to specifically identify the shares sold, the following requirements must be met:

Specific instructions to the broker or agent must be given by the customer, indicating the particular shares to be sold. These instructions must be given at the time of sale or transfer.
Written confirmation of this request must be received from the broker or agent within a reasonable time after the sale.

The individual shareholder bears the burden of proof that he or she owned and chose to sell the specific shares at the time of sale.

EXPLANATION

The FIFO method. Under the FIFO (first in, first out) method, the basis of shares acquired first represents the cost of the shares sold. In other words, the oldest shares held by the taxpayer are considered to be the first sold. The FIFO method is also a default method for the sales of securities other than the sale of mutual funds or dividend reinvestment plan (DRP) stock. If specific identification procedures are not or cannot be followed and the average basis approach (discussed below) is not elected, then the FIFO method will apply. Brokers must report the adjusted basis of mutual fund or DRP stock (for which a customer may average the basis of stock) in accordance with the broker’s default method unless the broker is notified in writing that a different permitted method is elected.

EXPLANATION

The single-category method using the average approach. The average basis method for non-covered securities (as defined earlier in this chapter) must be elected by the individual shareholder on his or her income tax return for the first taxable year for which the election applies and must indicate on such return that the average basis method was used to report the gain or loss on the sale or disposition of the securities. If you acquired the securities by gift and would like to elect the average basis method, you should consult your tax advisor regarding specific language that must be included in the statement you need to attach to your tax return to make this election. You must maintain adequate records to support the average cost basis reported on your return.

You can elect the average basis method for covered securities (as defined earlier in this chapter) by notifying your broker of the election in writing or you may make a written average basis election electronically. You may elect the average basis method at any time and the election takes effect for sales that occur after the election. To make the election for securities acquired by gift, you should consult your broker regarding specific language that must be included with your election. The election is made separately for each account holding or you may specify that it applies to all accounts with the particular broker, including future accounts yet to be created.

You may revoke an average basis election by the earlier of one year from the date of making the election or the first sale or other disposition of the stock following the election. After a revocation, your stock basis is the basis before averaging. However, you may change from the average basis method to another permissible method prospectively. You are not limited to the number of times or the frequency at which you can change your basis determination method. Following a change, your stock basis remains the same as the basis immediately before the change.

The average method permits the taxpayer to calculate his or her gain or loss based on the average price paid for the shares. With the single-category method, all shares are included in a single category; that is, the basis of each share is the total adjusted basis of all shares at the time of disposition divided by the total shares. In determining the holding period (long- or short-term), the shares disposed of are considered to be those shares acquired first (using a FIFO-type method, discussed earlier).

TAXALERT

Prior to 2012, if an average basis election was made, it was required to apply to all shares of a particular mutual fund in all accounts in which you held shares of that fund. Starting in 2012, you may elect to use average basis for shares of a particular mutual fund held in one account but not apply average basis to shares of that particular fund held in another account. If you elect to average the basis of mutual fund shares, you will compute separate averages for fund shares held in different accounts. Further, unless the fund or broker holding the fund shares elects otherwise, you will compute a separate average for fund shares in an account that is covered securities and a separate average for fund shares in an account that is not covered securities.

Beginning in 2012, mutual funds and DRP stocks that are a noncovered security are treated as being held in a separate account from stock that is a covered security. Because stock is averaged on an account-by-account basis starting in 2012, the basis of shares that are covered securities will be the average basis of only the covered securities and the basis of the shares that are noncovered securities will be the average basis of only the noncovered securities. However, if a broker has accurate basis information for shares that are noncovered securities and makes a “single-account election” for some or all of the shares, the shares subject to the single-account election are treated as covered securities and their basis is averaged along with the shares that are covered securities.

EXPLANATION

Mutual fund dividends. If an individual who purchases shares in a mutual fund receives a capital gain distribution and then sells the shares at a loss within 6 months after purchase, the loss is treated as a long-term capital loss to the extent of the capital gain distribution received. The rationale behind this rule is to prevent taxpayers from purchasing stock in a mutual fund to receive the capital gain distribution and then turn around and sell the stock at a loss when the fund’s value decreases as a result of the distributions. Without the rule, the capital gain distribution would be taxed at the lower long-term capital gain rate and the short-term capital loss would be available to offset other short-term capital gains taxed at the higher ordinary income tax rate.

Example

You pay $10,000 for ABC Mutual Fund on June 30. On July 1, ABC Mutual Fund pays you a long-term capital gain distribution of $1,000. The same day, the value of your ABC shares drops to $9,000. The $1,000 capital gain distribution will be taxed at the lower long-term rate. If the stock is sold within six months at a $1,000 loss, the loss will offset the capital gain distribution at the same lower long-term rate. If the stock is sold after six months but less than one year, the loss will offset gains at the higher short-term rate.

EXPLANATION

Sales or load charges. When a person invests in a mutual fund, he or she may be subject to a sales or load charge, which is similar to a commission. When shares are sold or redeemed, the sales or load charge is generally taken into account as part of the purchaser’s basis for purposes of computing gain or loss on the sale.

If an investor exchanges shares in a mutual fund for shares in the same “family” of funds or “complex” of funds, an additional sales or load charge may be waived or reduced if the investor acquires a reinvestment right (i.e., the right to acquire stock of one or more mutual funds without the payment of all or part of the standard load charge) on the original purchase. If such an exchange occurs within 90 days of the original purchase of mutual fund shares, the original sales or load charge will not be included as basis in determining the gain or loss on the exchange. This rule only applies to the extent that the additional sales or load charge is waived or reduced on the exchange. To the extent that the sales charge or load charge is not treated as basis in computing gain or loss, such a charge will be taken into account when you subsequently sell the shares.

Example

On February 1, Kurt purchased 100 shares of mutual fund A for $110, which included a $10 sales or load charge. On February 22 of the same year, Kurt exchanged these shares for 50 shares of mutual fund B, worth $115. Mutual fund B is in the same family as mutual fund A. The sales or load charge of $10 on Kurt’s purchase of mutual fund B was waived. Kurt’s gain or loss on the exchange is computed as follows:

Sales price of mutual fund A	$115
Cost basis of mutual fund A	(100)
Gain (loss)	$15

The sales or load charge of $10 on the purchase of mutual fund A did not affect the taxable gain or loss on the exchange but will become part of the basis of mutual fund B.

For more about mutual funds see chapter 40, Mutual funds.

TAXPLANNER

Share class exchange. A switch between share classes of the same mutual fund (Class B to Class A) is not a taxable event, but changing between different funds in the same mutual fund family is a taxable event even though there may be no sales or load change to get into the new fund. In the case of mutual funds with built-in losses at year-end, you might consider switching to a different fund within the same fund family to recognize the loss, and then move back into that fund after 30 days has passed. Whether two mutual funds are substantially identical requires a specific detailed analysis of the underlying economics of the funds. The IRS has not provided any guidance on the acceptable/unacceptable level of overlap between two funds. Seeking assistance from a tax professional is recommended. For more information about wash sales, see chapter 14, Sale of property.

Total net gain or loss. To figure your total net gain or loss, combine your net short-term capital gain or loss (Schedule D (Form 1040), line 7) with your net long-term capital gain or loss (Schedule D (Form 1040), line 15). Enter the result on Schedule D (Form 1040), Part III, line 16. If your losses are more than your gains, see Capital Losses, next. If both lines 15 and 16 of your Schedule D (Form 1040) are gains and your taxable income on your Form 1040 is more than zero, see Capital Gain Tax Rates, later.

TAXPLANNER

As discussed earlier, if short-term losses offset short-term gains and long-term losses offset long-term gains, then any excess short-term losses will offset excess long-term gain or excess long-term losses will offset short-term gains. With that in mind, if you have excess long-term gains at the end of the year that would be subject to tax at the preferential 15 or 20% rate, selling assets that would generate short-term losses would eliminate the long-term gain subject to the 15% or 20% rate. However, those assets with built-in short-term losses could have been used to offset short-term gains taxed at a potentially higher tax rate of up to 39.6%. Thus, using short-term losses to offset long-term gain reduces their “tax value” because you’re only saving up to 20% in long-term gain tax versus as much as 39.6%. On the other hand, if you have excess short-term gains at the end of the year that would be subject to ordinary income tax rates of up to 39.6%, selling assets that generate long-term losses would eliminate the short-term gain. This would, in effect, allow you to save up to 39.6% in taxes on with losses that might otherwise only saved you up to 20%.

TAXPLANNER

S corporation built-in gains tax. The Protecting Americans From Tax Hikes Act of 2015 signed by President Obama on December 18, 2015, permanently extended—retroactively to tax years beginning in 2015—the reduction of the recognition period from ten years to five years for avoiding S corporation built-in gains tax that previously only applied to 2012, 2013, and 2014.

When a C corporation elects to become an S corporation, the conversion is not a taxable event. However, following such a conversion, an S corporation must hold on to its assets for a certain period of time. If the S corporation sells an asset sooner (i.e., within five calendar years beginning with the first day of the first taxable year for which the S election is in effect for conversions occurring in taxable years beginning after 2010), then any built-in gain in such assets that existed at the time of the conversion is taxed to the S corporation at the existing highest marginal tax rate applicable to corporations; currently, 35%.

Under prior law, no tax was imposed on the net recognized built-in gain of an S corporation after the 7th year in the recognition period for taxable years beginning in 2009 and 2010 nor after the tenth year for taxable years beginning earlier.

Capital Losses

If your capital losses are more than your capital gains, you can claim a capital loss deduction. Report the amount of the deduction on line 13 of Form 1040, in parentheses.

EXAMPLES

Example 1

You have capital gains and losses for the year as follows:

	Short-Term	Long-Term
Gains	$700	$400
Losses	800	2,000

Your net deductible capital loss is $1,700, which you figure as follows:

Short-term capital losses	$800
Less: Short-term capital gains	(700)
Net short-term capital loss		$100
Long-term capital losses	$2,000
Less: Long-term capital gains	(400)
Net long-term capital loss		$1,600
Net deductible capital loss		$1,700

Your deduction is limited to the lesser of $3,000 ($1,500 if married filing separately) or your capital loss of $1,700.

Example 2

You have a net long-term capital loss of $1,600 and a net short-term capital gain of $450. Your deductible capital loss is $1,150 ($1,600 − $450).

Limit on deduction. Your allowable capital loss deduction, figured on Schedule D (Form 1040), is the lesser of:

$3,000 ($1,500 if you are married and file a separate return); or
Your total net loss as shown on line 16 of Schedule D (Form 1040).

You can use your total net loss to reduce your income dollar for dollar, up to the $3,000 limit.

Capital loss carryover. If you have a total net loss on line 16 of Schedule D (Form 1040) that is more than the yearly limit on capital loss deductions, you can carry over the unused part to the next year and treat it as if you had incurred it in that next year. If part of the loss is still unused, you can carry it over to later years until it is completely used up.

When you figure the amount of any capital loss carryover to the next year, you must take the current year’s allowable deduction into account, whether or not you claimed it and whether or not you filed a return for the current year.

When you carry over a loss, it remains long-term or short-term. A long-term capital loss you carry over to the next tax year will reduce that year’s long-term capital gains before it reduces that year’s short-term capital gains.

Figuring your carryover. The amount of your capital loss carryover is the amount of your total net loss that is more than the lesser of:

Your allowable capital loss deduction for the year; or
Your taxable income increased by your allowable capital loss deduction for the year and your deduction for personal exemptions.

If your deductions are more than your gross income for the tax year, use your negative taxable income in figuring the amount in item (2).

Complete the Capital Loss Carryover Worksheet in the Instructions for Schedule D or Pub. 550 to determine the part of your capital loss that you can carry over.

Example. Brian and Jackie sold securities in 2017. The sales resulted in a capital loss of $7,000. They had no other capital transactions. Their taxable income was $26,000. On their joint 2017 return, they can deduct $3,000. The unused part of the loss, $4,000 ($7,000 – $3,000), can be carried over to 2018.

If their capital loss had been $2,000, their capital loss deduction would have been $2,000. They would have no carryover.

Use short-term losses first. When you figure your capital loss carryover, use your short-term capital losses first, even if you incurred them after a long-term capital loss. If you have not reached the limit on the capital loss deduction after using the short-term capital losses, use the long-term capital losses until you reach the limit.

Decedent’s capital loss. A capital loss sustained by a decedent during his or her last tax year (or carried over to that year from an earlier year) can be deducted only on the final income tax return filed for the decedent. The capital loss limits discussed earlier still apply in this situation. The decedent’s estate cannot deduct any of the loss or carry it over to following years.

Joint and separate returns. If you and your spouse once filed separate returns and are now filing a joint return, combine your separate capital loss carryovers. However, if you and your spouse once filed a joint return and are now filing separate returns, any capital loss carryover from the joint return can be deducted only on the return of the spouse who actually had the loss.

Capital Gain Tax Rates

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates.

The term “net capital gain” means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss.

For 2017, the maximum capital gain rates are 0%, 15%, 20%, 25%, and 28%. See Table 16-1 for details.

Table 16-1 What Is Your Maximum Capital Gain Rate?

IF your net capital gain is from . . .	THEN your maximum capital gain rate is . . .
collectibles gain	28%
an eligible gain on qualified small business stock minus the Section 1202 exclusion	28%
unrecaptured Section 1250 gain	25%
other gain¹ and the regular tax rate that would apply is 39.6%	20%
other gain and the regular tax rate that would apply is 25%, 28%, 33%, or 35%	15%
other gain and the regular tax rate that would apply is 10% or 15%	0%

¹ “Other gain” means any gain that is not collectibles gain, gain on qualified small business stock, or unrecaptured Section 1250 gain.

TAXPLANNER

Long-term investment strategies. Investment strategies that emphasize capital appreciation over current income can significantly enhance your after-tax portfolio returns. For example, “buy-and-hold” investors may want to keep growth-oriented investments outside of tax-deferred accounts to benefit from the lower tax rates on long-term capital gains. Also, long-term gains in a tax-deferred account are taxed at ordinary income rates—currently as high as 39.6%—when withdrawn. Outside a tax-deferred account, those same long-term gains would be taxed at the more favorable capital gains rate. In addition, new investments in tax-deferred variable annuities will require much longer holding periods to outperform “comparable” investments held in a taxable account. Although mutual funds have not historically paid considerable attention to the impact of taxes on shareholder returns—with some notable exceptions—more fund families are developing “tax-managed” funds that seek to minimize taxable distributions to shareholders.

To take advantage of the 0%, 15%, and 20% rates, you should specifically identify shares of securities and/or mutual funds held more than 12 months prior to executing the sale. For tax purposes, you must provide your broker or fund representative with written selling instructions. You should also retain confirmation of these instructions in your personal files.

High-income taxpayers who have the option of deferring current compensation may be better off paying tax currently and reinvesting the after-tax proceeds in assets expected to appreciate over the long-term. For example, this may apply in the case of a corporate executive with significant nonqualified stock option holdings where the current option spread and associated tax liability is small, but the outlook for the company’s stock price is favorable.

Example. All of your net capital gain is from selling collectibles, so the capital gain rate would be 28%. If you are otherwise subject to a rate lower than 28%, the 28% rate does not apply.

Investment interest deducted. If you claim a deduction for investment interest, you may have to reduce the amount of your net capital gain that is eligible for the capital gain tax rates. Reduce it by the amount of the net capital gain you choose to include in investment income when figuring the limit on your investment interest deduction. This is done on the Schedule D Tax Worksheet or the Qualified Dividends and Capital Gain Tax Worksheet. For more information about the limit on investment interest, see Interest Expenses in chapter 3 of Pub. 550.

TAXPLANNER

Net capital gains. Net capital gains are not included in “investment income” for purposes of determining a taxpayer’s deduction for investment interest expense. However, you can elect to include capital gains as investment income. This election can be made for all or a portion of your capital gains. In addition, you can make one election for regular tax purposes and another for alternative minimum tax (“AMT”) purposes. If you make such an election, you must reduce the amount of capital gains that are otherwise eligible for the maximum capital gain tax rate by the amount included as investment income. The same election is available for qualified dividends that are taxed at capital gains rates and are also otherwise not considered to be investment income. See chapter 8, Dividends and other corporate distributions, for more details.

Collectibles gain or loss. This is gain or loss from the sale or trade of a work of art, rug, antique, metal (such as gold, silver, and platinum bullion), gem, stamp, coin, or alcoholic beverage held more than 1 year.

Collectibles gain includes gain from sale of an interest in a partnership, S corporation, or trust due to unrealized appreciation of collectibles.

Gain on qualified small business stock. If you realized a gain from qualified small business stock that you held more than 5 years, you generally can exclude some or all of your gain under Section 1202. The eligible gain minus your Section 1202 exclusion is a 28% rate gain. See Gains on Qualified Small Business Stock in chapter 4 of Pub. 550.

EXPLANATION

Generally, a taxpayer other than a corporation may exclude 100% of the gain from the sale of qualified small business stock (QSBS) acquired at original issue after September 27, 2010, and held for at least five years. For QSBS acquired at original issue after February 17, 2009, and before September 28, 2010, the exclusion drops to 75%. The exclusion is 50% for QSBS acquired before February 18, 2009. (The exclusion can be up to 60% for certain empowerment zone business stock acquired after December 21, 2000, and before February 18, 2009; the respective 75% and 100% exclusions also apply to QSBS of empowerment zone businesses.)

The gain eligible for exclusion is capped at the greater of 10 times the basis in the stock or $10 million in gain from all of the taxpayer’s transactions in stock of that corporation (held for more than 5 years); $5 million if married filing separately. See the TAXSAVER Gain on sale of qualified small business stock, in chapter 14, Sale of property, for details regarding the computation of the exclusion and the rules for determining whether stock is qualified small business stock.

The portion of the gain includible in taxable income from sales of QSBS acquired before September 28, 2010, is taxed at a maximum rate of 28% under the regular tax. For alternative minimum tax (AMT) purposes (see chapter 31, How to figure your tax), 7% of the amount excluded from gross income from sales of QSBS before September 28, 2010, is an AMT preference item and is added back to taxable income to arrive at alternative minimum taxable income. There is no AMT add back with respect to sales of QSBS after September 27, 2010, that qualify for the 100% exclusion.

The 3.8% Net Investment Income Tax (NIIT) is applied to the lesser of net investment income or excess modified adjusted gross income (MAGI) in excess of $200,000; ($250,000 if married filing jointly or a qualifying widow(er) with dependent child; $125,000 if married filing separately). Net investment income excludes whatever portion of the gain (50%, 60%, 75%, or 100%) that is eligible for the qualified small business stock exclusion.

For QSBS eligible for the 50% exclusion, the effective tax rate on gains realized is 14% for regular tax (as half of the gain is excluded and the other half is taxed at a 28% rate; i.e., 28% tax rate x 50%). The amount of the AMT tax preference item is 3.5% of the total gain realized (50% × 7%). For a taxpayer subject to the highest AMT tax rate of 28%, the effective maximum rate on the gain realized is 14.98%. The additional 0.98% results from the 7% add back of the excluded gain taxed at a 28% rate.

Although the 28% tax rate applicable to a sale of qualified small business stock (“QSBS”) remains the same for QSBS eligible for the 75% exclusion, the higher exclusion lowers the effective tax rate on gains realized for regular tax purposes to 7% (28% tax rate × 25%). The amount of the AMT tax preference item is 5.25% of the total gain realized (75% × 7%). For a taxpayer subject to the highest AMT tax rate of 28%, the effective maximum rate on the gain realized is 8.47%. The additional 1.47% results from the 7% add back of the excluded gain taxed at a 28% rate.

For QSBS acquired after September 27, 2010, 100% of the gain is excluded and there is no AMT preference item attributable for that sale.

Unrecaptured Section 1250 gain. Generally, this is any part of your capital gain from selling Section 1250 property (real property) that is due to depreciation (but not more than your net Section 1231 gain), reduced by any net loss in the 28% group. Use the Unrecaptured Section 1250 Gain Worksheet in the Schedule D (Form 1040) instructions to figure your unrecaptured Section 1250 gain. For more information about Section 1250 property and Section 1231 gain, see chapter 3 of Pub. 544.

EXPLANATION

Computing depreciation recapture. If you sell property at a gain, you must generally compute the portion of your gain that is depreciation recapture. Depreciation recapture is treated as ordinary income. The portion of the gain that is not depreciation recapture is treated as a Section 1231 gain. Unrecaptured Section 1250 gain on the sale of Section 1231 assets is subject to either the 20% maximum rate or, if the gain is attributable to adjustments in the basis of real estate, the 25% maximum rate. Complete Form 4797, Sales of Business Property, to determine the amount of your gain that is depreciation recapture.

Sale of depreciable personal property. The depreciation recapture rules for depreciable personal property are relatively simple, compared to the rules for real property. Depreciation recapture is the lesser of: (1) the gain recognized and (2) depreciation taken on the property since 1962. Note that under these rules if depreciable personal property is sold at less than its original cost, the full gain will inevitably be depreciation recapture.

Example

In 2013, Alan bought personal property that he used in his trade for $5,000. Alan sold the property for $2,500 in 2017. He had already taken $3,885 in depreciation. Alan computes his gain or loss as follows:

Sales price	$2,500
Purchase price	5,000
Less: Depreciation taken	(3,885)
Adjusted basis	1,115
Gain on sale	$1,385

Alan’s gain on the sale is $1,385, which is less than the $3,885 of depreciation he had taken on the property. Therefore, his depreciation recapture is $1,385. Because this represents the full gain on the sale, no portion of the gain is treated as a Section 1231 gain and all of it will be treated as ordinary income.

Assume instead that the property had appreciated and that Alan sold the property for $6,000:

Sales price	$6,000
Adjusted basis (computed above)	(1,115)
Gain on sale	$4,885

Because the depreciation Alan took on the property ($3,885) is less than the gain on the sale ($4,885), Alan reports the $3,885 depreciation taken as depreciation recapture. The remaining $1,000 of his gain ($4,885 − $3,885) is treated as a Section 1231 gain.

Explanation

Sale of depreciable real estate. The depreciation recapture rules relating to the sale of real estate are quite complex. These rules depend on: (1) when you placed the property in service, (2) what method of depreciation was used, and (3) whether the property was residential rental property or held for business use. It should be noted that no depreciation recapture should occur for real property acquired after 1986, because straight-line depreciation is the only method available for such property.

Residential real property acquired after 1980 and before 1987. Any gain on the sale of residential real property is ordinary income if the deductions taken under the Accelerated Cost Recovery System (ACRS) method of depreciation exceed the depreciation allowed under the 15-year straight-line method of depreciation. However, any gain you incur in excess of the amount you have to recapture is treated as a capital gain. For property acquired after March 15, 1984, the ACRS period is 18 years, and for property acquired after May 8, 1985, the ACRS period is 19 years.

Tax computation using maximum capital gain rates. Use the Qualified Dividends and Capital Gain Tax Worksheet or the Schedule D Tax Worksheet (whichever applies) to figure your tax if you have qualified dividends or net capital gain. You have net capital gain if Schedule D (Form 1040), lines 15 and 16, are both gains.

Schedule D Tax Worksheet. Use the Schedule D Tax Worksheet in the Schedule D (Form 1040) instructions to figure your tax if:

You have to file Schedule D (Form 1040); and
Schedule D (Form 1040), line 18 (28% rate gain) or line 19 (unrecaptured Section 1250 gain), is more than zero.

Qualified Dividends and Capital Gain Tax Worksheet. If you do not have to use the Schedule D Tax Worksheet (as explained above) and any of the following apply, use the Qualified Dividends and Capital Gain Tax Worksheet in the Instructions for Form 1040 or Form 1040A (whichever you file) to figure your tax.

You received qualified dividends. (See Qualified Dividends, in chapter 8.)
You do not have to file Schedule D (Form 1040) and you received capital gain distributions. (See Exceptions to Filing Form 8949 and Schedule D (Form 1040), earlier.)
Schedule D (Form 1040), lines 15 and 16, are both more than zero.

Alternative minimum tax. These capital gain rates are also used in figuring alternative minimum tax.

TAXALERT

Net Investment Income Tax. Regardless of whether net capital gains (the excess of your net long-term capital gains over your net short-term capital losses) are taxed at the lower 0%, 15%, or 20% preferential tax rates or are short-term capital gains subject to the higher regular income tax rates that apply to ordinary income, both short- and long-term capital gains, along with certain other investment income including dividends and interest income, may be subject to the 3.8% Net Investment Income Tax (NIIT). For individuals, the tax 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). These threshold dollar amounts are not indexed each year for inflation.

Net investment income subject to the NIIT is defined as investment income reduced by allocable deductions. NII includes the following types of short- and long-term capital gains—to the extent that such capital gains are not otherwise offset by capital losses:

Gains from the sale of stocks, bonds, and mutual funds.
Capital gain distributions from mutual funds.
Gain from the sale of investment real estate (including gain from the sale of a second home that is not a primary residence).
Gains from the sale of interests in partnerships and S corporations (to the extent you were a passive owner).

On the other hand, NII does not include any gains that are otherwise excludable from income for regular tax purposes. This includes gain excluded from the sale of your principal residence as discussed in chapter 15, Selling your home. NII also does not include gains attributable to an active trade or business conducted by a sole proprietor, partnership, or S corporation.

The NIIT is payable regardless of whether you otherwise pay any regular income tax or are subject to alternative minimum tax on your income.

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Table of Contents for CHAPTER 16: Reporting gains and losses

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Reporting Capital Gains and Losses

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Capital Gain Tax Rates

Table of Contents for
CHAPTER 16: Reporting gains and losses