Capital Gains and Capital Losses: Rules for Investors

26-Mar-2011

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Capital Gains and Capital Losses: Rules for Investors

Mar. 25 2011 – 6:41 pm | 1,362 views | 0 recommendations | 0 comments
By WILLIAM BALDWIN

Basis

This is IRS jargon for “cost, as adjusted.” If you buy 1,000 shares at $11 and pay an $8 commission, your basis is $11,008.

Gifts

Stock you give to friends or relatives retains your basis, if the stock has gone up in the meantime. If you buy a share of Google at $300, then give it to your grandson when it’s worth $600, his basis in the stock is $300.

What if you give away stock that has gone down? First of all, don’t do this. Sell the stock, take the capital loss and then give the cash.

If you made this mistake, there’s a special rule. Say you bought Google at $600 and gave it to Joey when it was worth $500. If Joey sells for more than $600, then his basis was $600. If he sells for less than $500, his basis was $500.

If he sells in between, he’s in a zero gravity region. No gain or loss.

Donations

You buy 100 Gilead Sciences at $30, hold for more than a year and then give it to charity when the stock is at $50. Your tax deduction is $5,000—the current market value. Your $2,000 of appreciation is never taxed.

Bequests

You buy stock for $3,000 and die holding it. At your death it’s worth $5,000. Your heir gets $5,000 as the basis. The $2,000 of appreciation is never taxed. This peculiar phenomenon is called “step-up.”

Long/short

Long-term gains get favorable tax rates. The minimum holding period for the lenient treatment is a year and a day. Usually.

For taxpayers on the lowest rungs of the IRS income ladder, the federal tax rate on long gains is 0%. For most people who have any gains to report, the rate is 15%.

In 2013 the max rate on stocks and bonds is going to 20%, except on positions held at least five years, for which the number will be 18%. To these official amounts please add five percentage points for a health care surcharge and an itemized deduction clawback.

Long-term gains on bullion and bullion trusts have a max rate of 28%.

Realization

Basic rule on capital gain tax is that you owe it only when and if you sell something. Paper gains are not taxed. This explains why families cling to valuable heirlooms, such as 50-story office buildings.

It explains why I think you should sell losers and hold onto winners indefinitely. More here.

There’s a Chicago exception. Certain derivatives—notably including commodity futures and stock index options—get 60/40 treatment. Every Dec. 31 you tote up your gains and losses and pretend that they are 60% long-term, 40% short-term, no matter whether you have sold them and no matter whether you have held them for a long or a short time.

Powershares DB Commodity Index Tracking Fund mostly owns futures and mostly gets 60/40 tax treatment.

Netting

Short gains get one treatment, long gains another. What happens if you have a loss on one variety of asset and a gain on the other? The netting idea is that all the plusses and minuses for each flavor of asset are combined to get a single net result. Then the two flavors are brought together in a new cocktail. The resulting gain or loss takes on the flavor of the larger ingredient.

Example: You have a net short-term gain of $6,000 and a net long-term loss of $7,000. The net net result is a long loss of $1,000.

The netting theme carries over to the many other flavors of assets. There are passive and nonpassive assets, garden-variety capital assets and quasi-capital assets, metallic commodities and nonmetallic, short things and long things, plain old office buildings and office buildings with depreciation recapture. You net out each flavor and then combine the flavors.

Example: You have a $6,000 net loss on stocks and an $8,000 long gain on SDPR Gold Trust. Your $2,000 net net is metallic. Tax, $560.

Carryforward

If your net net is a loss, you can use it against ordinary income at a rate of $3,000 a year. Unused portions get carried forward. Carryforwards retain their flavors. Usually.

Market discount

Some guy buys a bond for $100,000. It sinks. You buy it for $92,000. You cash it in at maturity for $100,000. His $8,000 loss is a capital loss, potentially of limited utility to him. Your $8,000 gain is fully taxable as if it were interest.

Amortization

You pay $106,000 for a $100,000 par value bond due in three years. You can amortize that $6,000 premium, writing it off against your coupon income. Your deduction is $2,000 a year. Approximately. The formula is complicated.

Return of capital

You bought Mack-Cali at the beginning of 2010 at $35. It paid a $1.80 dividend. But it had taxable income of only $1.45 a share. The other 45 cents was a “return of capital,” as if your principal were being returned to you. So you only pay tax on the $1.45. You are supposed to reduce the basis of your stock by 45 cents to $34.55. That increases the capital gain when you sell years from now.


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