Unit 7: Capital Gains and Losses for EA

What are considered capital assets?

Personal or investment items
Primary residence or vacation home
Furniture and vehicles
Boats, antiques, and collectibles
Stocks, bonds, and mutual funds
Digital assets like cryptocurrency

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Which losses from the sale of personal-use property are not deductible?

Losses on a main home, vacation home, personal-use furniture, or jewelry.

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How are gains and losses from capital assets typically reported?

Schedule D, Capital Gains and Losses
Form 8949, Sales and Other Dispositions of Capital Assets

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What types of transactions are reported on Form 8949?

Sale or exchange of capital assets, including digital assets
Gains from involuntary conversions
Nonbusiness bad debts
Worthless securities
Election to defer capital gain invested in a QOF

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What are assets held for business use or created by the taxpayer for purposes of earning revenue (e.g., copyrights, inventory) considered?

Non-capital assets

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What are some common non-capital assets?

Inventory held for sale to customers
Depreciable property used in a business
Real property used in a trade or business
Self-produced copyrights and artistic compositions
Accounts or notes receivable acquired by a business
Stocks and bonds held by professional securities dealers
Business supplies
Commodities and derivative financial instruments

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How are gains and losses from the sale of business assets reported?

On Form 4797, Sales of Business Property, with amounts flowing through to Form 1040, Schedule D for individual taxpayers.

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What is the holding period for short-term and long-term capital gains?

Long-term: more than one year (at least a year and a day)
Short-term: one year or less

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How is the holding period for gifted property determined?

It includes the donor’s holding period, allowing the recipient to ‘tack on’ the donor’s holding period.

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How is inherited property classified for tax purposes?

It is automatically classified as long-term, regardless of the actual holding period.

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How are capital gains or losses determined?

By comparing the amount realized with the adjusted basis of the property.

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What is the limit for deducting net capital losses against ordinary income?

$3,000 ($1,500 for MFS) per tax year, with unused losses carried over to subsequent years.

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What is the limit for claiming a net capital loss deduction for an individual taxpayer?

$3,000

The net capital loss deduction limit is $3,000 for individual taxpayers and $1,500 for married taxpayers filing separately. Any remaining losses must be carried forward to future tax years.

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How are digital assets like cryptocurrencies typically treated for tax purposes?

As property

The sale or disposition of digital assets such as cryptocurrencies and nonfungible tokens (NFTs) generally results in a capital gain or loss. Exchanging one digital asset for another is considered a taxable event.

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How are capital gain distributions from mutual funds taxed?

At long-term capital gains tax rates.

Regardless of how long a taxpayer has owned shares in the mutual fund, capital gain distributions are always taxed at long-term capital gains tax rates.

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What is a wash sale?

A sale where a taxpayer sells a security at a loss and repurchases a substantially identical security within 30 days.

The disallowed loss from a wash sale is added to the basis of the new stock or securities, postponing the loss deduction until the later disposition of the new stock or securities.

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True or False:

A taxpayer can deduct a loss from a wash sale if the spouse repurchases the identical stock within 30 days.

False

The wash sale rules apply even if the taxpayer’s spouse repurchases the identical stock within 30 days, regardless of filing jointly or separately.

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Fill in the blank:

The wash sale rules do not apply to _______.

professional securities dealers

A full-time securities dealer, someone who regularly buys and sells securities to customers in the ordinary course of their trade or business, is exempt from wash sale rules.

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How is the basis of a home affected for tax purposes?

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By increases or decreases

The adjusted basis is the taxpayer’s basis in the home increased by additions or improvements and decreased by deductible casualty losses, credits, and product rebates.

What is the formula for calculating adjusted basis in a home?

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Basis + Increases - Decreases = Adjusted Basis

Adjustments to basis include improvements with a useful life of more than one year and decreases such as deductible casualty losses.

What happens to capital losses upon the death of a taxpayer?

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They cannot be carried over to a beneficiary or an heir.

Any capital loss carryovers not used on the taxpayer’s final return are lost forever.

What is the effect of related party transaction rules on losses?

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Losses are not deductible.

A loss on the sale of property between related parties is generally not deductible, and disallowed losses cannot be recognized when the property is sold at a loss by the original party buyer.

What happens to a loss in a related party transaction when a taxpayer sells property at a loss?

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The loss cannot be deducted if the transaction involves related parties.

Related parties include immediate family members, controlled business entities, tax-exempt organizations controlled by the taxpayer, and closely-related trusts.

Define the ‘More Than 50% Control’ rule in related party transactions.

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If a taxpayer has more than 50% control of a business entity, any property transactions between the taxpayer and the business are subject to related party transaction rules.

This includes corporations, partnerships, or other business entities controlled by the taxpayer or family members.

What is an **installment sale**?

A **seller-financed purchase** of an asset where at least **one payment is received after the tax year of the sale**. ## Footnote Common types include the sale of business real estate, small businesses, and intangibles. It is reported on Form 6252 and may require Schedule D or Form 4797.

List the **components** of each payment received on an **installment sale**.

* Interest income * Return of the adjusted basis in the property * Gain on the sale ## Footnote The gain is determined by applying the gross profit percentage to the payment amount minus the interest portion.

What is the **default tax treatment** for **installment sales**?

The **installment method**, unless the taxpayer elects to report all gain in the year of sale. ## Footnote Electing out of the installment method requires reporting all gain in the year of sale, including any depreciation recapture.

# True or False: Publicly-traded securities can use the installment sale method.

False ## Footnote The installment method cannot be used for publicly-traded securities; gains must be reported in the year of sale.

What happens if a property sold in an installment sale to a related person is **disposed of within two years**?

The seller loses the benefit of installment sale reporting. ## Footnote Exceptions exist for involuntary conversions or death of the original seller or buyer.

How is a loss from **worthless securities** treated for tax purposes?

It is treated as though the securities were **sold for zero dollars** on the last day of the tax year. ## Footnote Taxpayers can amend returns for up to seven years to claim a loss from worthless securities, reported on Form 8949.

What is **Section 1244 stock**, and why is it beneficial to taxpayers?

Stock issued by a small domestic corporation that allows individuals to **deduct losses as ordinary losses** rather than capital losses. The maximum ordinary loss deduction is $50,000 ($100,000 if married filing jointly). ## Footnote Losses from Section 1244 stock can be treated as ordinary losses, not subject to the $3,000 capital loss limitation.

# Fill in the blank: To qualify for special tax treatment under IRC Section 1244, the corporation's aggregate capital must not have exceeded \_\_\_\_\_\_\_ when the stock was issued.

$1 million ## Footnote The corporation must also derive more than 50% of its income from active business operations.

# True or False: Long-term capital gains are taxed at lower rates than short-term gains.

True ## Footnote Long-term capital gains apply to assets held for more than one year.

How is the holding period of **investment property** calculated?

Start counting the day **after acquiring the property** and include the date of sale. ## Footnote Long-term is more than one year; short-term is one year or less.

What happens to **capital losses** that exceed the annual limit?

* They are carried forward to the next year. * They retain their character as short-term or long-term. * They must be reported on Schedule D. ## Footnote A taxpayer can deduct up to $3,000 ($1,500 if married filing separately) in capital losses against ordinary income annually.

What is the **capital loss deduction limit** for married filing separately (MFS) taxpayers?

$1,500 ## Footnote This is half of the $3,000 limit available to single or jointly filing taxpayers.

# True or False: A capital loss can be used by one spouse if the other spouse has a capital gain when filing separately.

False ## Footnote When filing separately, capital losses cannot be used to offset the other spouse's capital gains.

What happens to a **disallowed loss** under wash sale rules?

It is added to the basis of the new stock or securities. ## Footnote This adjustment postpones the loss deduction until the later disposition of the new stock or securities.

# True or False: Losses from related party transactions can be used to offset gains from the same transactions.

False ## Footnote Gains from related party transactions are taxable, while losses cannot be used to offset those gains.

# Fill in the blank: The installment method defers tax by reporting a portion of the gain as each \_\_\_\_\_\_\_ is received.

payment

Under what circumstances might a taxpayer **elect out of the installment** method?

When they anticipate higher future tax rates. ## Footnote Electing out requires reporting all gain in the year of sale.

What is the **loss limitation** that applies to **Section 1244 stock**?

Section 1244 stock allows an ordinary loss deduction of up to **$50,000** ($100,000 if MFJ), rather than being limited by the usual $3,000 capital loss rule.

What are the requirements for a **stock** to qualify as Section 1244 stock?

* Must be issued by a U.S. corporation. * Corporation's aggregate capital must not have exceeded $1 million when the stock was issued. * Corporation must derive more than 50% of its income from active business operations.

Who can take advantage of the **ordinary loss provisions** for Section 1244 stock?

Only the **original shareholders** of the stock while it was a small business corporation.

Define '**small business corporation**' for Section 1244 stock purposes.

A corporation where the aggregate amount of money and other property received for stock, as a contribution to capital, and as paid-in surplus, **does not exceed $1,000,000**.

Unit 7: Capital Gains and Losses Flashcards

Classify and calculate capital gains and losses in compliance with short- and long-term holding period rules. (45 cards)