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 a capital asset, such as stocks and bonds, you need to do some adding and subtracting.

The Netting Process

The netting process considers all gains and losses, short-term and long-term. Here are the steps:

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 and 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 and carryover any excess loss over $3,000 to the following year.
      • 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 gain 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 and 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 and 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 original 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.

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

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

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