Computing Capital Gains and Losses

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Updated for 2012

Computing Capital Gains and Losses

To determine whether you have a net short-term or net long-term capital gain or loss on the sale of stock, you need to do a little adding and subtracting. This is where the netting process comes in. This is just a matter of combining all short-term gains and all short-losses to find your net short-term gain or loss. Then, combining all long-term gains and all long-term losses to find your net long-term gain or loss.

How you report and how you're taxed on the results of the netting process depends on what the result is.

For example, if you end up with a Net S/T gain and a Net L/T gain the Net S/T gain is taxed at ordinary income tax rates while the Net L/T gain is taxed at the lower capital gains rates. If you end up with an overall net capital loss, the amount of the loss that you may deduct is limited.

A net capital loss is subject to an annual deduction limit of $3,000. The excess over $3,000 must be carried over to the following year and used in the computation of capital gains and losses of that year. The character of the loss remains the same. In other words, if you carry over a net long-term capital loss to the following year, the loss remains a net-long-term capital loss in that year.

The Netting Process

Here are the steps in the netting process:

Step 1:

Figure short-term (S/T) gains and losses. These are capital assets sold or exchanged with a holding period of one year or less.

Add up all S/T gains
Add up all S/T losses
Subtract total S/T losses from total S/T gains
If S/T gains exceed S/T losses, you have a net S/T gain
If S/T losses exceed S/T gains, you have a net S/T loss.

Step 2:

Figure long-term (L/T) gains and losses. These are capital assets sold or exchanged with a holding period of more than one year.

Add up all L/T gains
Add up all L/T losses
Subtract total L/T losses from total L/T gains
If L/T gains exceed L/T losses, you have a net L/T gain
If L/T losses exceed L/T gains, you have a net L/T loss.

Step 3:

Combine the results in steps 1 and 2.

If you end up with a Net S/T gain and a Net L/T gain:
- The Net S/T gain is taxed at ordinary income tax rates.
  - These are the same tax rates that apply to your regular tax computation.
- The Net L/T gain is taxed at the lower capital gains rates.

If you end up with a Net S/T gain and a Net L/T loss:
- If the Net S/T gain exceeds the Net L/T Loss, the Net S/T gain is taxed at ordinary income tax rates.
- If the Net L/T loss exceeds the Net S/T Gain, deduct up to $3,000 of the loss from other income on Form 1040, Line 13 (tax year 2011).
- Carryover any excess loss over $3,000 to the following year.
  - Tax preparation reminder: Keep a record of any carryover losses so you don't overlook them when preparing your return in the following year.
If you end up with a Net S/T loss and Net L/T gain:
- If the Net L/T gain exceeds the Net S/T loss, you have a Net L/T gain. The lower capital gains rates apply.
- If the Net S/T loss exceeds the Net L/T gains, you have a Net S/T loss. Deduct up to $3,000 from other income on Form 1040, Line 13 (tax year 2011).
- Carryover any excess loss over $3,000 to the following year.
If you end up with a Net S/T loss and a Net L/T loss:
- First, deduct up to $3,000 of the S/T loss from other income on Form 1040, Line 13.
- If the S/T loss exceeds $3,000, carry over both the excess S/T loss and the unused L/T Loss to the following year.
- Keep the S/T Loss and L/T loss amounts separate because.
  - They retain their character as S/T and L/T in the carryover year and are used in the computation of net capital gains and losses in that year.
If the S/T loss is under the $3,000 deduction limit, then deduct whatever amount of the L/T loss is needed to reach the $3,000 limit for that tax year.

Like-kind-exchanges: Losses incurred in line-kind-exchanges are not deductible.

Paper losses: A drop in value of a capital asset (a paper loss) doesn't qualify for a deduction.

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