Question of the Week

Topic: REG: Capital Gains and Losses

REG: Capital Gains and Losses

In Year 4, an individual had the following capital gains and losses from sales of publicly traded stock:

Long-term capital gain	$25,000
Short-term capital gain	$5,000
Long-term capital loss	$8,000
Short-term capital loss	$20,000

In addition, Section 1244 stock from a qualified small business was issued to the individual for $90,000 in June, Year 1, and was sold for $25,000 in February, Year 4. How much ordinary loss and capital loss can the individual deduct in Year 4?

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	Ordinary loss	Capital loss
	A. $0	$3,000 (20%)
	B. $50,000	$3,000 (48%)
	C. $50,000	$13,000 (17%)
	D. $65,000	$13,000 (15%)

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Explanation

When a taxpayer disposes of a capital asset A property owned by a taxpayer that is not inventory, a receivable, Section 1231 property, self-created intangible property, or consumable supplies. the gain (loss) will be classified as either long-term (LT)A way to classify assets that are held longer than 1 year by the owner. or short-term (ST)A way to classify assets that are held for 1 year or less by the owner. depending on the holding period. These gains and losses are netted and generally result in an overall net capital gain or loss. If a loss results, individuals may deduct up to $3,000 of the capital loss against ordinary income. Any unused losses may be carried forward indefinitely.

To incentivize investment in small business, a loss on Section 1244 stockStock in a domestic corporation that was a small business (ie, received less than $1,000,000 in equity funding) when the stock was originally issued. To qualify, the stock can only have been issued for money and property (other than securities), and it cannot have received more than 50% of gross receipts from certain passive and investment activities in the last five years. allows individuals to reclassify part a capital loss to an ordinary loss (ie, no $3,000 limitation). The statutory amount reclassified as an ordinary loss is $50,000 ($100,000 if married filing jointly). Any excess remains a capital loss.

In this scenario, the individual has potential $65,000 ($25,000 − $90,000) Section 1244 loss. However, only $50,000 can be treated as an ordinary loss. The remaining $15,000 ($65,000 − $50,000) is netted with the other capital gains and losses to produce a $13,000 capital loss, which is limited to $3,000.

LT capital gain (brokerage)	$25,000
LT capital loss (brokerage)	($8,000)
LT capital loss (balance from Section 1244 stock)	($15,000)
Net LT capital gain		$2,000

ST capital gain	$5,000
ST capital loss	($20,000)
Net ST capital loss		($15,000)

Net capital gain (loss)		($13,000)
Capital loss deduction (limited) $3,000

Therefore, the individual can deduct a $50,000 ordinary loss and a $3,000 capital loss. The remaining $10,000 ($13,000 − $3,000) loss is carried forward to future tax years.

Things to remember:
A net capital gain (loss) is the combination of all capital gains and losses during the tax year. If the result is a net capital loss, the deduction is limited to $3,000. Up to $50,000 ($100,000 if married filing jointly) of losses from Section 1244 stock (ie, qualified small business stock), can be reclassified as an ordinary loss. Any excess is netted with the other capital gains (losses).

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