Taxation Issues - Netting Capital Gains and Losses and Wash Sales


Netting Capital Gains and Losses
If an investor makes a number of trades in a particular year, the end result could be a mix of long- and short-term capital gains and losses. The IRS is specific as to how these gains and losses are to be netted against each other. Here are the steps:

  • Net short-term gains against short-term losses.
  • Net long-term gains against long-term losses.
  • If both holding periods result in gains (or both in losses), they are reported separately on Schedule D.
  • If one holding period results in a gain and the other in a loss, they are then netted against each other.
  • If capital losses exceed capital gains, up to $3,000 can be deducted against ordinary income in any one year.
  • Unused capital losses can be carried forward indefinitely to future years - each year, unused capital losses will first be netted against the current year's capital gains, followed by the $3,000 deduction against ordinary income.

Wash Sales
If you own a stock that has gone down in value, but you believe it will rise significantly in the future, it could be tempting to sell the stock and enjoy the resulting capital loss and then buy it back so you can enjoy the future capital gain. But the IRS does not permit you to take the loss if you buy the same (or similar) security back within 30 days of the sale. This is known as a "wash sale".

There are several ways to avoid the "wash sale" rule and still take advantage of the underlying strategy:

  • Wait more than 30 days to buy back the security; or
  • Buy a security with similar characteristics (e.g., sell shares of ABC growth mutual fund and buy shares of XYZ growth mutual fund)

The wash rule applies to transactions before and after the sell date. For example, you cannot buy additional shares of the security on October 1, sell the original shares on October 20 and then buy more shares of the same security on November 10. In essence, the wash sale rule covers a period of 61 days: the sell date plus 30 days before and 30 days after.


Look Out!
Don\'t be confused by the prohibition against buying back the"same (or similar) security" and the strategy of "buying a security with similar characteristics." In the first instance, "similar security" refers to securities that are convertible to the sold security, (such as call options, rights, warrants or convertible bonds), which can result in owning the security at a later date.


The article Selling Losing Securities for a Tax Advantage contains valuable information on how to perform tax-loss harvesting to help reduce taxes on portfolio gains:


Exam Tips and Tricks
Consider these sample exam questions:

  1. Your client bought 100 shares of ABC stock on June 30. What is the first day of the following year the stocks could be sold for a capital gain?
    1. June 1
    2. July 1
    3. July 2
    4. June 30

The correct answer is "c", since the holding period begins July 1 (the day after the purchase). Long-term capital gains are only permitted if the holding period is greater than one year, so the correct answer is July 2.

  1. Your client has a net short-term gain of $3,000 and a net long-term loss of $8,000. Which of the following statements are true?
    1. The short-term gain is fully taxable
    2. $3,000 of capital loss is deductible against earned income
    3. There is a long-term loss carried forward of $2,000
    4. There is no loss carried forward
    1. I & III
    2. I & IV
    3. II & III
    4. I, II, & III

The correct answer is "c". The gain and the loss are netted and result in a $5,000 long-term loss. $3,000 of that can be used in the current year as a deduction against earned income, and $2,000 will be carried forward.

Corporate and Trust Income Tax


Related Articles
  1. Forex

    Global Utilities: Exploring Revenue Trends & Fundamentals

    Analyze global revenue exposure in the utilities sector to learn about the impact of currency, regulation and economic growth on geographic contributions.
  2. Home & Auto

    4 Alternatives to a Traditional Mortgage

    If you can't qualify for or don't want a traditional mortgage, one of these options might be right for you.
  3. Home & Auto

    Understanding Mortgage Impound Accounts

    Home buyers with low down payments may get stuck with higher mortgage payments. Find out what you get for the extra money.
  4. Investing

    Municipal Bonds Offer Something More for Everyone

    Are municipal bonds really for me? The popular perception is that tax-exempt income only benefits those investors in the highest tax brackets.
  5. Retirement

    5 Top Alternatives to a Reverse Mortgage

    If you have substantial home equity and don't want to do a reverse mortgage to tap it for retirement expenses, cost out these viable alternatives.
  6. Credit & Loans

    What Is an Alt-A Mortgage?

    Called "liar loans" for their low documentation requirements, Alt-A mortgages were hot until the subprime crisis. Now Wall Street wants to bring them back.
  7. Home & Auto

    Understanding Mortgage-Backed Securities

    Find out the meaning of this popular asset-backed security and its benefits for banks and investors.
  8. Investing

    Berkshire Hathaway Stock: Capital Structure Analysis (BRK.A)

    Review the capital structure of Berkshire Hathaway, and understand how equity and debt capitalization and enterprise value may interact with each other.
  9. How the Future of Driverless Trucks Impacts the Global Economy

    A successful cross-border trip of a convoy of self-driving trucks across Europe gives insight to a future of autonomous vehicles to replace human drivers.
  10. Markets

    Chart of the Week: Why It’s Time for Caution?

    This week’s chart helps illustrate why we’re taking a more cautious view of global equities over the near term.
RELATED TERMS
  1. Primary Mortgage Market

    The market where borrowers and mortgage originators come together ...
  2. 100% Mortgage

    A mortgage loan in which the borrower receives a loan amount ...
  3. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against ...
  4. Mortgage Originator

    An institution or individual that works with a borrower to complete ...
  5. Secondary Mortgage Market

    The market where mortgage loans and servicing rights are bought ...
  6. Mortgage Pool

    A group of mortgages held in trust as collateral for the issuance ...
RELATED FAQS
  1. How safe are money market accounts?

    Learn the difference between a money market account and a money market fund. Both savings vehicles are relatively safe, but ... Read Answer >>
  2. Why is Belize considered a tax haven?

    Explore the factors that make Belize one of the most modern and corporate-friendly tax havens in the world, including its ... Read Answer >>
  3. What is an assumable mortgage?

    The purchase of a home is a very expensive undertaking and usually requires some form of financing to make the purchase possible. ... Read Answer >>
  4. Why would a homebuyer need to take out PMI (private mortgage insurance)?

    Learn why some home buyers are required to take out private mortgage insurance (PMI), and how it affects the total monthly ... Read Answer >>
  5. Why does the majority of my mortgage payment start out as interest and gradually ...

    When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the ... Read Answer >>
  6. What are the disadvantages of a Roth IRA?

    Get informed about Roth IRAs, which have a few disadvantages, including limited access to funds and contribution limits based ... Read Answer >>
Hot Definitions
  1. Physical Capital

    Physical capital is one of the three main factors of production in economic theory. It consists of manmade goods that assist ...
  2. Reverse Mortgage

    A type of mortgage in which a homeowner can borrow money against the value of his or her home. No repayment of the mortgage ...
  3. Labor Market

    The labor market refers to the supply and demand for labor, in which employees provide the supply and employers the demand. ...
  4. Demand Curve

    The demand curve is a graphical representation of the relationship between the price of a good or service and the quantity ...
  5. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  6. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
Trading Center