A Capital Idea…Gains and Losses

Now that we’re in the thick of tax season, I want to briefly discuss a topic that affects many taxpayers in this country, capital gains and losses. In my 11/7/11 post, I wrote briefly about the new reporting requirements for both brokers/mutual funds, and taxpayers. In this article, I’d like to discuss in a little more detail exactly what constitutes capital gains or losses.

Did you know that almost everything you own and use for personal purposes, pleasure, or investment is considered a ‘capital asset’ for tax purposes? Well now you know (that, and $2.50 will get you on the NYC subway!) Capital assets include a home, household furnishings, and stocks & bonds, among other things.

When you sell a capital asset, the difference between what you paid for the asset (its basis) and its sales price is capital gain or capital loss. Here’s the fun part…you must report all capital gains. Now here’s the bad part…you may only deduct capital losses on investment property, not on personal-use property. What this means is that you can deduct the loss you had on the sale of your Worldcom stock, but you can’t deduct the loss on the sale of your Ford Pinto.

Capital gains and losses are classified as long-term or short-term, and this is important, since the tax rate on long-term gains is generally 15%, while short-term gains are taxable at your marginal tax rate, which can go as high as 35%. In order to be classified as long-term, the capital asset must have been held more than one year (e.g. a year and a day, or more).

All capital gains and losses are netted out to figure out what needs to be included in your taxable income. If everything nets out to a loss, you can deduct the excess losses on your tax return to reduce your other income (wages, interest, dividends, etc), but there’s an annual limit of $3,000 that can be used. For the unfortunate taxpayers who had huge losses on stocks from the last market crash, the excess of the $3,000 that can be deducted annually can be carried forward and applied in subsequent tax years until used up. If, in subsequent years you have capital gains, the losses that were carried forward can be applied against the capital gains, dollar for dollar.

As I mentioned in my 11/7/11 article, IRS created Form 8949 which must be used starting with 2011 returns, to report capital gains and losses. The totals on the 8949 forms then get carried over to Schedule D, and ultimately on to the 1040.

I hope this helps with your understanding of capital gains and losses, if you were fuzzy about them previously. I welcome any comments you may have on this subject, and please pass along this article to friends, enemies, colleagues, or somebody who could use some extra tax knowledge on what might otherwise be a mundane day!

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