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Capital Gain and Loss Tax Issues
By cpa | May 15, 2008
Investors
Whenever you sell an investment at a profit, you will probably owe the IRS a tax known as a capital gains tax. This is true for most investments, including stock, mutual funds, bonds, options, or business. Capital gains are the amount by which an asset’s selling price exceeds its initial purchase price. A realized capital gain is an investment that has actually been sold at a profit. The term capital gain is often used to mean realized capital gain. An investment that hasn’t been sold yet usually does not have capital gain tax issues.
Most investors’ federal long-term capital gains taxed at 15 percent. Taxpayers in 15% or lower income brackets pay only 5 percent on most investment earnings. To take advantage of the low 5% or 15% tax rate, you should try to hold more than one year to qualify.
If you’re an investor, you already know how to report your income and related investment expenses. You should have received a 1099-B if you sold stocks or mutual funds in 2007. You should keep a record of all your stock transactions, and report all of the investments sold on Schedule D. You can only take up to $3,000 capital loss exceeding net capital gain from other types of income. You carryover the unused loss to offset capital gains or you can use $3,000 loss to offset your other types of income in the future.
If your stock declared dividends in 2006, you should have received 1099-Div. You have to report dividend income under schedule B. A reader asked if a foreigner who was already withholds 30% from its dividend income, is he required to file tax return. I advice the taxpayer to file a return, because he could possible receive a nice refund. I will write an separate article for international tax issues.
You report any margin interest expense paid on Schedule A as an interest expense deduction. You also report any related investment expenses (such as investment newspapers and publications, stock analysis computer programs, etc. on Schedule A as an itemized deduction, subject to the 2% Adjusted Gross Income (AGI) limitation.
You also have to be careful about wash sale. In general you have a wash sale if you sell stock at a loss, and buy substantially identical securities within 30 days before or after the sale. You cannot deduct your loss.
The unfortunate fact is, if you don’t itemize your deductions or your AGI is high relative to your investment expenses, your investment expenses could be rendered useless.
Example: Scott has $2,200 of investment expenses related to her stock portfolio. Sally doesn’t itemize her deductions. Therefore, the $2,200 of expenses will not reduce Sally’s taxes.
Traders
If you buy and sell stocks very frequently, you may be able to qualified as a trader instead of an investor. There is a different tax-reporting world open up to you. IRS does not have a clear guideline about who is an investor and who is a trader. The general rules are as follow:
The trader generally holds positions 30 days or less. Virtually none of the trader’s positions are held for more than a year.
The trader’s goal is to profit from short-term swings in the market and the associated stock price.
The trader spends a lot of time doing just trading stocks!
If you qualify for trader status, your stock gains or losses are still reported on Schedule D, but your trading expenses are reported on Schedule C, and there are no AGI restrictions or limitations thwarting the deduction of these expenses.
If Scott on the above example is qualified as a trader, he can deduct his $2,200 of trading expenses on his schedule C without limitation on Schedule A. However, traders are still subject to many of the same rules as the investor, such as $3,000 capital loss rules, wash sales rules.
According to IRC 1402, capital gains and losses are not subject to the SE tax. Many people overpaid SE taxes should consult a CPA specializes on stock trading and possible claim the past-overpaid taxes.
Mark-To-Mark Election
The IRC 475, allows traders to make an election that allows them to “mark” their stock holdings to the fair market value (FMV) at the end of the tax year. If the election is made, all securities held by the trader are deemed to have been “sold” at the end of the tax year, and then immediately repurchased. This causes the trader to realize tax profits on stocks that haven’t really been sold yet.
Why in the world would anyone want to make an election that would cause her to pay taxes on “paper” profits each year? For two very good reasons: Making the election will remove the annual $3,000 limitation on net capital losses and the wash sale rules no longer apply to the trader.
If you determine that you’re a trader and you’re looking forward to making the MTM election for the current tax year, in general, you are required to file the appropriate election and you’ll have to follow the procedures 99-17 with 2007tax return if you want to election to be effective in 2007. There are special rules for new taxpayers, corporation and Limited Liability Company.
Topics: TAX |