This article will discuss the general aspects of capital gains and losses, the brokers reporting to investors, how and where they are reported on Form 1040 and supporting schedules.
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 2016, the net LTCG will be taxed at various rates depending on the tax bracket:
|15% or less||0%|
|16% – 39.5%||15%|
In addition to the tax on the net LTCG, taxpayers will pay an additional 3.8% Medicare tax on net investment income (gross investment income less investment related expenses). Form 8960 is used to compute the tax. For details, see the author’s article “Tax Provisions of the 2012 American Health Care Act”, September 17, 2013. The tax applies for taxpayers who have MAGI exceeding:
- $250,000 for married filing joint and “surviving spouses”.
- $200,000 for single and heads of household.
- $125,000 for married filing separate.
Definition of 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 are 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.
This 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.
- Trading activity: covered securities-basis reported to IRS, covered securities-basis not reported to IRS, covered securities-basis not reported to the IRS, and non-covered securities.
- Date securities were acquired.
- Date of Sale.
- Name of securities sold.
- Number of shares sold.
- Proceeds (sales price less sales fees) from sale of securities.
- Cost or other basis (includes brokerage fees).
- Gain or loss.
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 basis 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 cannot be changed.
Form 8949 – Sales and Dispositions of Capital Assets
Security sales are first reported on this form which is divided into two parts: short-term and long-term sales. Each of these sections is divided into three parts:
- transactions reported on form 1099-B showing basis was reported to IRS.
- transactions reported on form 1099-B showing basis not reported to IRS.
- transactions not reported on form 1099-B.
Information reported in each of these sections is:
- Description of property (e.g., 100 shares of Dell),
- Date acquired (month, day, year).
- Date sold or disposed of (month, day, year).
- Cost or other basis.
- Adjustments, if any, to gain or loss (e.g. disallowed loss on wash sale-see explanation and example in Part II).
- 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.
Losses first offset gains in the respective short-term and long-term categories. Total losses in excess of gains are deductible up to $3,000 against ordinary income. Any unused losses can be carried indefinitely to future years to offset capital gains and ordinary income 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.