unit 7: capital gains and losses

Question 1

What are capital assets?

Answer 1

Capital assets are personal or investment items owned by a taxpayer, such as a primary residence, vacation home, furniture, vehicles, antiques, collectibles, stocks, bonds, mutual funds, and digital assets (e.g., cryptocurrency), excluding those held by professional securities dealers.

Question 2

Example of a capital asset transaction:

Answer 2

Sarah buys a painting for $1,000 as an investment. Five years later, she sells it for $5,000. The painting is a capital asset, and she reports a $4,000 long-term capital gain on Form 8949 and Schedule D.

Question 3

What are the tax rules for gains on personal-use assets?

Answer 3

Gains from the sale of personal-use assets (e.g., main home, vacation home, furniture, jewelry) are usually taxable, subject to certain exclusions, but losses are not deductible and cannot offset capital gains.

Question 4

Example of a taxable gain on a personal-use asset:

Answer 4

Tom sells his personal-use boat, purchased for $10,000, for $15,000 after two years. He must report a $5,000 long-term capital gain on his tax return, but if he sold it for $8,000, the $2,000 loss would not be deductible.

Question 5

What are the special tax rates for collectibles?

Answer 5

Long-term capital gains on collectibles (e.g., artwork, coin collections) held for more than one year are taxed at the individual’s ordinary tax rate, capped at a maximum of 28%.

Question 6

Example of tax rates for collectibles:

Answer 6

Emma sells a rare stamp collection, held for three years, for a $10,000 gain. Her ordinary income tax rate is 35%, but the gain is taxed at 28%, saving her tax compared to ordinary income rates.

Question 7

What is Schedule D used for?

Answer 7

Schedule D is used to report the summary of capital gains and losses from the sale of investment property and most capital gain or loss transactions, netting all transactions for the year.

Question 8

Example of using Schedule D:

Answer 8

John sells stocks and a vacation home in 2024, reporting each transaction on Form 8949. He transfers the totals to Schedule D, which shows a net long-term capital gain of $12,000 for the year.

Question 9

What is Form 8949 used for?

Answer 9

Form 8949 reports specific details of each capital asset sale or exchange, including digital assets, involuntary conversions, nonbusiness bad debts, worthless securities, and qualified opportunity fund transactions, with parts for short-term and long-term assets.

Question 10

Example of using Form 8949:

Answer 10

Lisa sells cryptocurrency and stocks in 2024. She reports each transaction’s basis, sale price, and gain/loss on Form 8949, separating short-term and long-term transactions, then summarizes on Schedule D.

Question 11

What are noncapital assets?

Answer 11

Noncapital assets are business-use or revenue-generating assets, such as inventory, depreciable business property, real property used in a trade, self-produced copyrights, accounts receivable, and stocks held by professional securities dealers.

Question 12

Example of a noncapital asset transaction:

Answer 12

Maria, a retailer, sells inventory for $20,000, purchased for $15,000. The $5,000 gain is reported as ordinary income on Schedule C, not as a capital gain, since inventory is a noncapital asset.

Question 13

What is Form 4797 used for?

Answer 13

Form 4797 is used to report gains and losses from the sale of business property (noncapital assets), with amounts flowing to Schedule D for individual taxpayers, except for inventory sales reported on Schedule C or F.

Question 14

Example of using Form 4797:

Answer 14

Mike, a landscaper, sells a used truck used in his business for a $2,000 loss. He reports the sale on Form 4797, and the loss flows to Schedule D, reducing his taxable income.

Question 15

What is the holding period for capital assets?

Answer 15

The holding period determines if a capital gain or loss is short-term (one year or less) or long-term (more than one year). It starts the day after acquisition and includes the sale date.

Question 16

Example of determining a holding period:

Answer 16

Anna buys stock on March 1, 2024, and sells it on March 2, 2025. The holding period is just over one year (March 2, 2024, to March 2, 2025), so any gain or loss is long-term.

Question 17

What is “tacking on” for gifted property?

Answer 17

For gifted property, the recipient’s holding period includes the donor’s holding period, allowing the combined period to determine if the gain or loss is short-term or long-term.

Question 18

Example of tacking on for gifted property:

Answer 18

Bob gifts stock to his son, held for 8 months. The son holds it for 5 months and sells it. The total holding period (13 months) makes the gain long-term, reported on Form 8949.

Question 19

What is the holding period rule for inherited property?

Answer 19

Inherited property is automatically classified as long-term, regardless of how long the beneficiary or decedent held it, resulting in long-term capital gain or loss on sale.

Question 20

Example of inherited property holding period:

Answer 20

Claire inherits a car from her aunt in 2024 and sells it two months later for a $3,000 gain. The gain is long-term due to the inherited property rule, reported on Schedule D.

Question 21

How is capital gain or loss calculated?

Answer 21

Capital gain or loss is calculated by subtracting the adjusted basis from the amount realized (sale price minus selling expenses) for a stock or property disposition, reported in the year of sale.

Question 22

Example of calculating capital gain or loss:

Answer 22

Tim sells land for $50,000, with $5,000 in selling expenses and a $30,000 adjusted basis. The amount realized is $45,000, resulting in a $15,000 capital gain reported on Form 8949.

Question 23

What is the net capital loss deduction limit?

Answer 23

A taxpayer can deduct up to $3,000 ($1,500 for married filing separately) of net capital losses against ordinary income per year, with excess losses carried over to future years.

Question 24

Example of net capital loss deduction limit:

Answer 24

Rachel has a $10,000 capital loss and $40,000 in wages. She deducts $3,000 against her wages, reducing taxable income to $37,000, and carries over $7,000 to the next year.

Question 25

What is a capital loss carryover?

Answer 25

Unused capital losses exceeding the $3,000 ($1,500 for MFS) annual deduction limit are carried over indefinitely, retaining their short-term or long-term character, but are lost upon the taxpayer’s death.

Question 26

Example of capital loss carryover:

Answer 26

Mark has a $12,000 long-term capital loss in 2024. He deducts $3,000, carrying over $9,000 as a long-term loss to 2025, reported on Schedule D until fully used.

Question 27

How are digital assets treated for tax purposes?

Answer 27

Digital assets (e.g., cryptocurrencies, NFTs) are treated as property, with their sale or exchange resulting in capital gain or loss, and exchanges between digital assets are taxable events.

Question 28

Example of a digital asset transaction:

Answer 28

Alex buys Bitcoin for $5,000 and exchanges it for Ethereum worth $15,000 after two years. He reports a $10,000 long-term capital gain on Form 8949 as a taxable event.

Question 29

What are capital gain distributions from mutual funds?

Answer 29

Capital gain distributions are profits from a mutual fund’s investments, reported to shareholders on Form 1099-DIV, always taxed as long-term capital gains regardless of holding period.

Question 30

Example of capital gain distributions:

Answer 30

Tina owns mutual fund shares for 6 months and receives a $500 capital gain distribution reported on Form 1099-DIV. She reports it as a long-term capital gain on Schedule D.

Question 31

How is the sale of mutual fund shares reported?

Answer 31

The sale of mutual fund shares results in a taxable gain or loss, reported on Form 1099-B and Form 1040, Schedule D, with the basis included by brokers.

Question 32

Example of selling mutual fund shares:

Answer 32

Sam sells mutual fund shares purchased for $10,000 for $12,000 after 18 months. The $2,000 long-term capital gain is reported on Form 1099-B and Schedule D.

Question 33

What is a wash sale?

Answer 33

A wash sale occurs when a taxpayer sells a security at a loss and repurchases a substantially identical security within 30 days before or after, disallowing the loss deduction.

Question 34

Example of a wash sale:

Answer 34

Jane sells 100 shares at a $1,000 loss and buys 100 identical shares 20 days later. The loss is disallowed due to the wash sale rule, and the $1,000 is added to the new shares’ basis.

Question 35

What happens to the basis in a wash sale?

Answer 35

The disallowed loss from a wash sale is added to the basis of the newly purchased stock or securities, postponing the loss deduction until the new securities are sold.

Question 36

Example of wash sale basis adjustment:

Answer 36

Paul sells stock for a $2,000 loss and repurchases it within 30 days. The $2,000 loss is disallowed and added to the new stock’s basis, deductible when he later sells the repurchased shares.

Question 37

What is the amount realized in a home sale?

Answer 37

The amount realized is the selling price (cash, notes, or other property) minus selling expenses (e.g., realtor’s commissions, legal fees, advertising fees, loan charges like points).

Question 38

Example of calculating amount realized in a home sale:

Answer 38

Laura sells her home for $300,000, paying $15,000 in realtor’s fees and $5,000 in legal fees. Her amount realized is $280,000 ($300,000 - $20,000 in expenses).

Question 39

How is the basis in a home determined?

Answer 39

The basis is the purchase cost (for bought homes), building expenses plus land cost (for constructed homes), fair market value at death (for inherited homes), or donor’s adjusted basis (for gifted homes).

Question 40

Example of determining basis in a home:

Answer 40

Greg inherits a home valued at $200,000 at his father’s death. His basis is $200,000. If he sells it for $210,000, he reports a $10,000 long-term capital gain.

Question 41

What is the adjusted basis in a home?

Answer 41

The adjusted basis is the original basis plus increases (e.g., improvements with a useful life over one year) minus decreases (e.g., deductible casualty losses, credits, rebates).

Question 42

Example of calculating adjusted basis in a home:

Answer 42

Sue buys a home for $150,000 and adds a $20,000 kitchen remodel. A $5,000 casualty loss reduces the basis. Her adjusted basis is $165,000 ($150,000 + $20,000 - $5,000).

Question 43

What are the related party transaction loss rules?

Answer 43

Losses on sales between related parties (e.g., immediate family, controlled entities) are not deductible. Gains are taxable, and disallowed losses may reduce gains on subsequent sales to unrelated parties.

Question 44

Example of related party transaction loss rules:

Answer 44

Tom sells stock to his sister for a $3,000 loss, which is not deductible. She sells it later for a $4,000 gain. Her taxable gain is $1,000, reduced by the $3,000 disallowed loss.

Question 45

What is the more than 50% control rule?

Answer 45

Losses on transactions between a taxpayer and a business they control (over 50% ownership, including family ownership) are not deductible, except in complete corporate liquidations.

Question 46

Example of more than 50% control rule:

Answer 46

Lisa, owning 60% of a corporation, sells equipment to it at a $5,000 loss. The loss is not deductible due to the control rule, but a gain on a similar sale would be taxable.

Question 47

What is an installment sale?

Answer 47

An installment sale is a seller-financed sale where at least one payment is received after the tax year of sale, commonly for business real estate, small businesses, or intangibles, reported on Form 6252.

Question 48

Example of an installment sale:

Answer 48

Jack sells a rental property for $500,000, with $100,000 down and $400,000 over four years. He reports the gain proportionally on Form 6252 each year as payments are received.

Question 49

What is the gross profit percentage in an installment sale?

Answer 49

The gross profit percentage is the gross profit (selling price minus adjusted basis) divided by the selling price, used to allocate gain to each installment payment received.

Question 50

Example of gross profit percentage:

Answer 50

Kim sells land for $200,000, with a $50,000 basis, yielding a $150,000 gross profit. The gross profit percentage is 75% ($150,000/$200,000). A $40,000 payment results in a $30,000 taxable gain.

Question 51

What does electing out of the installment method mean?

Answer 51

Electing out means reporting the entire gain in the year of sale, not deferring it, useful if future tax rates are expected to be higher, requiring full gain reporting on Schedule D or Form 4797.

Question 52

Example of electing out of installment method:

Answer 52

Sam sells a business for $300,000 over five years, with a $100,000 basis. Expecting higher future taxes, he elects out, reporting the $200,000 gain in 2024 on Schedule D.

Question 53

What are worthless securities?

Answer 53

Worthless securities (stocks, bonds, stock rights) that lose all value are treated as sold for $0 on the last day of the tax year, reported on Form 8949, with a seven-year amendment period.

Question 54

Example of worthless securities:

Answer 54

Tara’s 1,000 shares, bought for $10,000, become worthless in 2024 due to bankruptcy. She reports a $10,000 capital loss on Form 8949, marking it “WORTHLESS” with a December 31 sale date.

Question 55

What is abandonment of securities?

Answer 55

Abandonment is permanently surrendering all rights to a worthless security without receiving consideration, allowing a capital loss deduction, reported on Form 8949 as “WORTHLESS.”

Question 56

Example of abandonment of securities:

Answer 56

Ken owns stock worth $0 after a company’s bankruptcy. He abandons it in 2024, reporting a $5,000 long-term capital loss on Form 8949, marked “WORTHLESS,” offsetting other income.

Question 57

What is Section 1244 stock?

Answer 57

Section 1244 stock is stock in a small U.S. corporation (capital ≤ $1 million) allowing ordinary loss treatment up to $50,000 ($100,000 for joint filers) for original shareholders, not subject to the $3,000 capital loss limit.

Question 58

Example of Section 1244 stock:

Answer 58

Omar, a single filer, sells Section 1244 stock for a $20,000 loss (basis $30,000, sold for $10,000). He deducts the full $20,000 as an ordinary loss, not limited to $3,000, on his tax return.