Capital Gains and Losses in General

A capital gain is a profit from the sale of a capital asset - you get more from the sale than what you paid for the asset. A capital loss is when the proceeds from the sale of a capital asset are less than the purchase price.

When you sell capital assets and have gains or losses, special tax rules apply.

Long-Term or Short-Term

Capital gains and losses are either long-term or short-term. A long-term capital gain or loss occurs when you hold a capital asset for more than one year before you sell or dispose of it. A short-term capital gain or loss occurs when you hold a capital asset for one year or less before you sell it.

How long have you held an asset? Begin counting on the day after you received the asset and include the day you sold it.

Advantage of Capital Gains over Ordinary Income

There are two main advantages that capital gains have over ordinary income:

• You don't pay tax on a capital gain until you sell the asset, and you get to choose when to sell
• Capital gains are taxed at special rates that are generally much lower than the rate on ordinary income

Capital Losses

Capital losses may be used to offset capital gains. If there are no capital gains, or if the capital losses are larger than the capital gains, you can deduct the capital loss against other income. There is a limit of a $3,000 deduction per year but if your overall capital loss is greater than $3,000, you may carry over the excess to the next year.

Determining Effect of Capital Gain Transactions

To determine the effect of capital asset transactions, follow these steps:

• Separate the gains and losses into short-term and long-term groups
• Combine all short-term gains and losses to determine the net short-term capital gain or loss
• Combine all long-term gains and losses to determine the net long-term capital gain or loss
• Calculate any net capital gain, which is the excess of the net long-term capital gains over the net short-term capital losses

If there are net gains from both short-term and long-term transactions, they're treated separately. Short-term capital gain is fully includible in income and is taxed at ordinary rates. The special, low tax rates apply only when there's a net capital gain.

Necessity of Sale or Exchange

Generally, you can't have a capital gain or loss if your property isn't sold or exchanged. A mere loss in value usually doesn't create a deductible loss. For example, if you can't get a zoning change to take full advantage of a parcel of property, there's no capital loss if you decide to keep the property.

Questions for Your Attorney

• Can capital losses be carried over for more than one year if the loss for one year is more than $6,000?
• If I sell a capital asset that was given to me to as a gift, how do I calculate the gain or loss?
• What happens if a capital asset becomes completely worthless and I can't sell it?