Capital Gains and Losses

How to Compute 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, you need to do some adding and subtracting, called the netting process.

The Netting Process

The netting process considers all long-term and all short-term gains and losses.

Steps in the Netting Process:

Step 1: Figure short-term (S/T) gains and losses (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 (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 have 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 have 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 net loss from other income on Form 1040 and carryover the excess loss that exceeds $3,000 to the following year(s).
    • A net loss carried over to the following year is used to compute net capital gains and losses of that year. The character of the loss as short-term or long-term remains the same is any carryover year.
      • Reminder: Keep a record of carryover losses to avoid overlooking them when preparing your return in a subsequent 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 and carryover any excess loss over $3,000 to the following year(s).
  • If you have a net S/T loss and a net L/T loss:
    • First, deduct up to $3,000 of the S/T loss from income reported on Form 1040. 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 carried over as separate amounts (don't combine them) 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 subsequent years.
  • If a net S/T loss is under the $3,000 annual limit and you don't have a net L/T/ loss, deduct the S/T loss up to the amount income reported on Form 1040. If any amount of the S/T loss remains, carry it over to the next year.
  • If a net L/T loss is under the $3,000 annual limit and you don't have a net S/T/ loss, deduct the L/T loss up to the amount income reported on Form 1040. If any amount of the L/T loss remains, carry it over to the next year.
Like-kind Exchanges:

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

Paper-loss:

A drop in market value of a capital asset before it is sold or exchanged is simply an unrealized loss (referred to as a paper loss) and does not qualify for a deduction.