Income Tax Aspects of Non-business Capital Gains And Losses – Part I

This article is divided in to three parts. Part I will cover the general aspects of capital gains and losses and how and where they are reported on Form 1040 and supporting schedules. Part II covers special situations involving sales of securities-wash sales, gifts, and inheritances. Part III will cover mutual funds, stock rights, debt securities purchased at a discount and premium, and exchanges.

Part I

It is advantageous to have investment income in the form of long-term (held longer than one year) capital gains (LTCG) because they are taxed at a lower rate than ordinary income. For 2013, the net LTCG will be taxed at various rates depending on the tax bracket:

Tax Bracket        LTCG Rate

15 or less             0%

16-39.5%           15%

39.6%                20%

In addition to the tax on the net LTCG, taxpayers will pay an additional 3.8% tax on net investment income (gross investment income less investment related expenses). For details see the author’s article “Tax Provisions of the 2012 American Health Care Act”, September 23, 2013 published on TaxConnections.com.

Capital Assets

A capital asset is any property owned by a taxpayer. This includes investments, personal residence, auto, furniture or any other property. But only losses on sale of property held for income producing purposes is tax deductible. Capital gain dividends from mutual funds are taxed as a LTCG just as sales of securities are. Capital gain dividends are reported to the IRS and the taxpayer on form 1099. They are entered on form 1040, Schedule B as part of total dividends received and then reported separately on form 1040, line 9b (qualified dividends). They are also entered on Schedule D, line 13.

Form 1099-B

What it is used for – Form 1099-B is used by brokers to report to the IRS the proceeds from sales and exchanges of securities. It reports the following information in separate categories for short-term and long-term transactions:

(1) Trading activity: covered securities-basis reported to IRS; non-covered securities- basis not reported to IRS;.

(2) Date of Sale.

(3) Name of securities sold

(4) Number of shares sold.

(5) Proceeds (sales price less sales fees) from sale of securities.

(6) Date securities were acquired.

(7) Cost or other basis.

(8) Gain or loss

An illustration of form 1099-B with actual taxpayer information is presented in my Tax Library.

Broker Reporting Basis to IRS for Securities sold – The Emergency Economic Stabilization Act of 2008 included new tax-reporting requirements. Brokers will be required to report the adjusted cost basis of securities sold to the IRS. The new requirements are designed to have accurate reporting of investors gains and losses. This will allow the IRS to determine the correctness of capital gains and losses reported on the tax return.

Securities affected are:

1. Responsibility for covered securities: Brokers will report cost basis to IRS. Taxpayers ill use form 1099-B data in preparing their tax returns.

Time period covered:

Equities * acquired on or after 1/1/11

Mutual funds, DRIP (dividend reinvestment plans), ETFs (exchange traded funds) ** acquired after 1/1/12.

Other specified securities including fixed income and options *** acquired on or after 1/1/13

2. Responsibility for uncovered securities: Brokers will NOI report cost basis to IRS. Taxpayers will use form 1099-B data in preparing their tax returns.

Time period covered:

Equities acquired prior to 1/1/11

Mutual funds, DRIP (dividend reinvestment plans), ETFs (exchange traded funds) ** acquired prior to 1/1/12

Other specified securities including fixed income and options *** acquired prior to 1/1/13

* Equities include corporate stock (other than stock in a regulated investment company

[RIC] or stock acquired in connection with a DRIP. Sec.6045(g)(3)(C)(ii) provides that the applicable date is January 1, 2011

** For stock in a RIC (RIC stock) or stock acquired in connections with a DRIP.

Sec. 6045(g)(3)(C)(ii) provides that the applicable date is January 1, 2012.

*** For any other specified securities, Sec. 6045(g)(3)(C)(iii) provides that the applicable date is January 1, 2013, or a later date to be determined in the future. The reporting rules related to options transactions apply only to options granted or acquired on or after January 1, 2013, as provided in Sec. 6045(h)(3).

An illustration of form 1099B, with actual taxpayer information, is presented in my Tax Library.

Reporting Capital Gains and losses on Tax Return

Multiple lots for Same Securities

When the same securities are purchased at different times and cost, the taxpayer must determine how to determine the cost of the securities sold. The following methods are used.

First-in, first-out (FIFO). This is used as a default for securities sold that are not eligible for the average cost method. The average cost method may be applied as a default for mutual funds, but even if it is applied, lots are to be sold in a first-in, first-out manner.

Specific Identification: In this method, the taxpayer must identify the specific lot being sold. It can be done either at the time of trade or through a standing order (e.g., using high cost as a default method). Each broker may offer different lot selection choices.

Specified lot decisions must be made before the trade settles. If the taxpayer desires to specify a particular lot to sell, or to change the cost basis method for a sale, it can be done only until the settlement date of the trade. Once the trade settles, the method used will be final.

Form 8949-Sales and Dispositions of Capital Assets

Security sales are first reported on this form. It is divided into two parts: short-term and long-term sales. Each of these sections is divided into three parts:

(1) transactions reported on form 1099-B showing basis was reported to IRS.

(2) transactions reported on form 1099-B showing basis not reported to IRS.

(3) transactions not reported on form 1099-B.

Information reported in each of these sections is:

(a) description of property (e.g., 100 shares of Dell),

(b) Date acquired (month, day, year).

(c) Date sold or disposed of (month, day, year).

(d) Cost or other basis,

(d) Adjustments, if any, to gain or loss (e.g. disallowed loss on wash sale-see explanation and example in Part II.), (e) gain or loss.

Totals from form 8949 are transferred to page 1 of Schedule D-Capital Gains and Losses. Schedule D, page 1, consists of two parts: Part I is used to report short-term sales and part II is used to report long-term sales. The net capital gain or loss from Schedule D, page 2, is then entered on form 1040, line 13.

An illustration of form 8949 and Schedule D page one and two, with actual taxpayer information, is presented in my Tax Library.

Capital Losses

Losses first offset gains. Losses in excess of gains are deductible up to $3,000 against ordinary income. Any unused losses are carried over to future years to offset gains and ordinary income. They can be carried over indefinitely until used up. Loss carryovers retain their respective short-term or long-term status. They are reported on form 1040, Schedule D. Short-term carryovers are entered on line 6 to be combined with other short-term gains and losses. Long-term carryovers are entered on line 14 to be combined with other long-term gains and losses.

In accordance with Circular 230 Disclosure

Dr. Goedde is a former college professor who taught income tax, auditing, personal finance, and financial accounting and has 25 years of experience preparing income tax returns and consulting. He published many accounting and tax articles in professional journals. He is presently retired and does tax return preparation and consulting. He also writes articles on various aspects of taxation. During tax season he works as a volunteer income tax return preparer for seniors and low income persons in the IRS’s VITA program.

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