Publication 550 |
2000 Tax Year |
What Is a Sale or Trade?
Words you may need to know (see Glossary):
- Equity option
- Futures contract
- Marked to market
- Nonequity option
- Options dealer
- Regulated futures contract
- Section 1256 contract
- Short sale
This section explains what is a sale or trade. It also explains
certain transactions and events that are treated as sales or trades.
A sale is generally a transfer of property for money or a mortgage,
note, or other promise to pay money. A trade is a transfer of property
for other property or services, and may be taxed in the same way as a
sale.
Sale and purchase.
Ordinarily, a transaction is not a trade when you voluntarily sell
property for cash and immediately buy similar property to replace it.
The sale and purchase are two separate transactions. But see
Like-Kind Exchanges under Nontaxable Trades,
later.
Redemption of stock.
A redemption of stock is treated as a sale or trade and is subject
to the capital gain or loss provisions unless the redemption is a
dividend or other distribution on stock.
Dividend versus sale or trade.
Whether a redemption is treated as a sale, trade, dividend, or
other distribution depends on the circumstances in each case. Both
direct and indirect ownership of stock will be considered. The
redemption is treated as a sale or trade of stock if:
- The redemption is not essentially equivalent to a dividend
-- see Dividends and Other Corporate Distributions in
chapter 1,
- There is a substantially disproportionate redemption of
stock,
- There is a complete redemption of all the stock of the
corporation owned by the shareholder, or
- The redemption is a distribution in partial liquidation of a
corporation.
Redemption or retirement of bonds.
A redemption or retirement of bonds or notes at their maturity
generally is treated as a sale or trade. See Stocks, stock
rights, and bonds and Discounted Debt Instruments
under Capital or Ordinary Gain or Loss, later.
In addition, a significant modification of a bond is treated as a
trade of the original bond for a new bond. For details, see section
1.1001-3 of the regulations.
Surrender of stock.
A surrender of stock by a dominant shareholder who retains control
of the corporation is treated as a contribution to capital rather than
as an immediate loss deductible from taxable income. The surrendering
shareholder must reallocate his or her basis in the surrendered shares
to the shares he or she retains.
Trade of investment property for an annuity.
The transfer of investment property to a corporation, trust, fund,
foundation, or other organization, in exchange for a fixed annuity
contract that will make guaranteed annual payments to you for life, is
a taxable trade. If the present value of the annuity is more than your
basis in the property traded, you have a taxable gain in the year of
the trade. Figure the present value of the annuity according to
factors used by commercial insurance companies issuing annuities.
Transfer by inheritance.
The transfer of property of a decedent to the executor or
administrator of the estate, or to the heirs or beneficiaries, is not
a sale or other disposition. No taxable gain or deductible loss
results from the transfer.
Termination of certain rights and obligations.
The cancellation, lapse, expiration, or other termination of a
right or obligation with respect to property that is a capital asset
(or that would be a capital asset if you acquired it) is treated as a
sale. Any gain or loss is treated as a capital gain or loss.
This rule does not apply to the retirement of a debt instrument.
See Redemption or retirement of bonds, earlier.
Worthless Securities
Stocks, stock rights, and bonds (other than those held for sale by
a securities dealer) that became worthless during the tax year are
treated as though they were sold on the last day of the tax year. This
affects whether your capital loss is long-term or short-term. See
Holding Period, later.
If you are a cash basis taxpayer and make payments on a negotiable
promissory note that you issued for stock that became worthless, you
can deduct these payments as losses in the years you actually make the
payments. Do not deduct them in the year the stock became worthless.
How to report loss.
Report worthless securities on line 1 or line 8 of Schedule D (Form
1040), whichever applies. In columns (c) and (d), print "Worthless."
Enter the amount of your loss in parentheses in column (f).
Filing a claim for refund.
If you do not claim a loss for a worthless security on your
original return for the year it becomes worthless, you can file a
claim for a credit or refund due to the loss. You must use Form 1040X,
Amended U.S. Individual Income Tax Return, to amend your
return for the year the security became worthless. You must file it
within 7 years from the date your original return for that year had to
be filed, or 2 years from the date you paid the tax, whichever is
later. (Claims not due to worthless securities or bad debts generally
must be filed within 3 years from the date a return is filed, or 2
years from the date the tax is paid.) For more information about
filing a claim, see Publication 556,
Examination of Returns,
Appeal Rights, and Claims for Refund.
Constructive Sales
of Appreciated
Financial Positions
You are treated as having made a constructive sale when you enter
into certain transactions involving an appreciated financial position
(defined later) in stock, a partnership interest, or certain debt
instruments. You must recognize gain as if the position were disposed
of at its fair market value on the date of the constructive sale. This
gives you a new holding period for the position that begins on the
date of the constructive sale. Then, when you close the transaction,
you reduce your gain (or increase your loss) by the gain recognized on
the constructive sale.
Constructive sale.
You are treated as having made a constructive sale of an
appreciated financial position if you:
- Enter into a short sale of the same or substantially
identical property,
- Enter into an offsetting notional principal contract
relating to the same or substantially identical property,
- Enter into a futures or forward contract to deliver the same
or substantially identical property (including a forward contract that
provides for cash settlement), or
- Acquire the same or substantially identical property (if the
appreciated financial position is a short sale, an offsetting notional
principal contract, or a futures or forward contract).
You are also treated as having made a constructive sale of an
appreciated financial position if a person related to you enters into
a transaction described above with a view toward avoiding the
constructive sale treatment. For this purpose, a related person is any
related party described under Related Party Transactions,
later in this chapter. Exception for nonmarketable securities.
A contract for sale of any stock, debt instrument, or partnership
interest that is not a marketable security is not a constructive sale
if it settles within 1 year of the date you enter into it.
Exception for certain closed transactions.
Do not treat a transaction as a constructive sale if all of the
following are true.
- You closed the transaction before the end of the 30th day
after the end of your tax year.
- You held the appreciated financial position throughout the
60-day period beginning on the date you closed the transaction.
- Your risk of loss was not reduced at any time during that
60-day period by holding certain other positions.
If a closed transaction is reestablished in a substantially similar
position during the 60-day period beginning on the date the first
transaction was closed, this exception still applies if the
reestablished position is closed before the end of the 30th day after
the end of your tax year in which the first transaction was closed
and, after that closing, (2) and (3) above are true.
Appreciated financial position.
This is any interest in stock, a partnership interest, or a debt
instrument (including a futures or forward contract, a short sale, or
an option) if disposing of the interest would result in a gain.
Exceptions.
An appreciated financial position does not include the following.
- Any position from which all of the appreciation is accounted
for under marked to market rules, including section 1256 contracts
(described later under Section 1256 Contracts Marked to
Market).
- Any position in a debt instrument if:
- The position unconditionally entitles the holder to receive
a specified principal amount,
- The interest payments (or other similar amounts) with
respect to the position are payable at a fixed rate or a variable rate
described in section 1.860G-1(a)(3) of the regulations,
and
- The position is not convertible, either directly or
indirectly, into stock of the issuer (or any related person).
- Any hedge with respect to a position described in
(2).
Certain trust instruments treated as stock.
For the constructive sale rules, an interest in an actively traded
trust is treated as stock unless substantially all of the value of the
property held by the trust is debt that qualifies for the exception to
the definition of an appreciated financial position (explained in (2)
above).
Sale of appreciated financial position.
A transaction treated as a constructive sale of an appreciated
financial position is not treated as a constructive sale of any other
appreciated financial position, as long as you continue to hold the
original position. However, if you hold another appreciated financial
position and dispose of the original position before closing the
transaction that resulted in the constructive sale, you are treated as
if, at the same time, you constructively sold the other appreciated
financial position.
Transitional rules.
A special rule may apply if you entered into a transaction before
June 9, 1997, that was a constructive sale of an appreciated financial
position. Under this rule, you do not take either the position or the
transaction into account to determine whether any other constructive
sale has occurred after June 8, 1997. This rule applies only if,
before September 4, 1997, you clearly identified the transaction and
the position in your records as offsetting. This rule does not apply
as of the date you close the transaction or stop holding the position.
Transitional rule for decedents.
A special rule may apply if there was a constructive sale before
June 9, 1997, of an appreciated financial position held by a decedent
dying after June 8, 1997. Under this rule, treat the position and the
transaction that resulted in the constructive sale as property
constituting rights to receive an item of income in respect of a
decedent. However, gain on the position that accrues after the
transaction is closed is not treated as income in respect of a
decedent.
This rule applies only if both the following requirements are met.
- The transaction resulting in the constructive sale remains
open (with respect to the decedent or any related person)--
- For at least 2 years after the date of the transaction,
and
- At any time during the 3-year period ending on the date of
the decedent's death.
- The transaction was not closed before September 5,
1997.
Section 1256 Contracts
Marked to Market
If you hold a section 1256 contract at the end of the tax year, you
generally must treat it as sold at its fair market value on the last
business day of the tax year.
Section 1256 Contract
A section 1256 contract is any:
- Regulated futures contract,
- Foreign currency contract,
- Nonequity option, or
- Dealer equity option.
Regulated futures contract.
This is a contract that:
- Provides that amounts that must be deposited to, or can be
withdrawn from, your margin account depend on daily market conditions
(a system of marking to market), and
- Is traded on, or subject to the rules of, a qualified board
of exchange.
A qualified board of exchange is a domestic board of trade
designated as a contract market by the Commodity Futures Trading
Commission, any board of trade or exchange approved by the Secretary
of the Treasury, or a national securities exchange registered with the
Securities and Exchange Commission.
Foreign currency contract.
This is a contract that:
- Requires delivery of a foreign currency that has positions
traded through regulated futures contracts (or settlement of which
depends on the value of that type of foreign currency),
- Is traded in the interbank market, and
- Is entered into at arm's length at a price determined by
reference to the price in the interbank market.
Bank forward contracts with maturity dates that are longer than the
maturities ordinarily available for regulated futures contracts are
considered to meet the definition of a foreign currency contract if
the above three conditions are satisfied.
Special rules apply to certain foreign currency transactions. These
transactions may result in ordinary gain or loss treatment. For
details, see Internal Revenue Code section 988 and regulations
sections 1.988-1(a)(7) and 1.988-3.
Nonequity option.
This is any listed option (defined below) that is not an equity
option. Nonequity options include debt options, commodity futures
options, currency options, and broad-based stock index options. A
broad-based stock index is based upon the value of a group of
diversified stocks or securities (such as the Standard and Poor's 500
index).
Warrants based on a stock index that are economically,
substantially identical in all material respects to options based on a
stock index are treated as options based on a stock index.
Cash-settled options.
Cash-settled options based on a stock index and either traded on or
subject to the rules of a qualified board of exchange are nonequity
options if the Securities and Exchange Commission (SEC) determines
that the stock index is broad based.
This rule does not apply to options established by November 10,
1994, or before the SEC determines that the stock index is broad
based.
Listed option.
This is any option that is traded on, or subject to the rules of, a
qualified board or exchange (as discussed earlier under Regulated
futures contract). A listed option, however, does not include an
option that is a right to acquire stock from the issuer.
Dealer equity option.
This is any listed option that, for an options dealer:
- Is an equity option,
- Is bought or granted by that dealer in the normal course of
the dealer's business activity of dealing in options, and
- Is listed on the qualified board of exchange where that
dealer is registered.
An options dealer is any person registered with an
appropriate national securities exchange as a market maker or
specialist in listed options.
Equity option.
This is any option:
- To buy or sell stock, or
- That is valued directly or indirectly by reference to any
stock, group of stocks, or stock index.
Equity options include options on certain narrow-based stock
indexes, but exclude options on broad-based stock indexes and options
on stock index futures.
An equity option, however, does not include an option for any group
of stocks or stock index if:
- The Commodities Futures Trading Commission has designated a
contract market for a contract based on that group or index, and that
designation is in effect, or
- The Secretary of the Treasury determines that the option
meets the legal requirements for such a designation.
Marked to Market Rules
A section 1256 contract that you hold at the end of the tax year
will generally be treated as sold at its fair market value on the last
business day of the tax year, and you must recognize any gain or loss
that results. That gain or loss is taken into account in figuring your
gain or loss when you later dispose of the contract, as shown in the
example under 60/40 rule, below.
Hedging exception.
The marked to market rules do not apply to hedging transactions.
See Hedging Transactions, later.
60/40 rule.
Under the marked to market system, 60% of your capital gain or loss
will be treated as a long-term capital gain or loss, and 40% will be
treated as a short-term capital gain or loss. This is true regardless
of how long you actually held the property.
Example.
On June 23, 1999, you bought a regulated futures contract for
$50,000. On December 31, 1999 (the last business day of your tax
year), the fair market value of the contract was $57,000. You have a
$7,000 gain recognized on your 1999 tax return, treated as 60%
long-term and 40% short-term capital gain.
On February 2, 2000, you sold the contract for $56,000. Because you
already recognized a $7,000 gain on your 1999 return, you recognize a
$1,000 loss ($57,000 - $56,000) on your 2000 tax return, treated
as 60% long-term and 40% short-term capital loss.
Limited partners or entrepreneurs.
The 60/40 rule does not apply to dealer equity options that result
in capital gain or loss allocable to limited partners or limited
entrepreneurs (defined later under Hedging Transactions).
Instead, these persons should treat all these gains or losses as short
term under the marked to market system.
Terminations and transfers.
The marked to market rules also apply if your obligation or rights
under section 1256 contracts are terminated or transferred during the
tax year. In this case, use the fair market value of each section 1256
contract at the time of termination or transfer to determine the gain
or loss. Terminations or transfers may result from any offsetting,
delivery, exercise, assignment, or lapse of your obligation or rights
under section 1256 contracts.
Loss carryback election.
An individual or partnership having a net section 1256 contracts
loss (defined later) for 2000 can elect to carry this loss back 3
years, instead of carrying it over to the next year. See How To
Report, later, for information about reporting this election on
your return.
The loss carried back to any year under this election cannot be
more than the net section 1256 contracts gain in that year. In
addition, the amount of loss carried back to an earlier tax year
cannot increase or produce a net operating loss for that year.
The loss is carried to the earliest carryback year first, and any
unabsorbed loss amount can then be carried to each of the next 2 tax
years. In each carryback year, treat 60% of the carryback amount as a
long-term capital loss and 40% as a short-term capital loss from
section 1256 contracts.
Do not treat any part of a net section 1256 contracts loss carried
to 1997 as a 28% rate gain or loss. (For 1997, certain long-term
capital gains and losses from property held 18 months or less were
treated as 28% rate gains and losses (discussed under Reporting
Capital Gains and Losses)).
If only a portion of the net section 1256 contracts loss is
absorbed by carrying the loss back, the unabsorbed portion can be
carried forward, under the capital loss carryover rules, to the year
following the loss. (See Capital Losses under
Reporting Capital Gains and Losses, later.) Figure your
capital loss carryover as if, for the loss year, you had an additional
short-term capital gain of 40% of the amount of net section 1256
contracts loss absorbed in the carryback years and an additional
long-term capital gain of 60% of the absorbed loss. In the carryover
year, treat any capital loss carryover from losses on section 1256
contracts as if it were a loss from section 1256 contracts for that
year.
Net section 1256 contracts loss.
This loss is the lesser of:
- The net capital loss for your tax year determined by taking
into account only the gains and losses from section 1256 contracts, or
- The capital loss carryover to the next tax year determined
without this election.
Net section 1256 contracts gain.
This gain is the lesser of:
- The capital gain net income for the carryback year
determined by taking into account only gains and losses from section
1256 contracts, or
- The capital gain net income for that year.
Figure your net section 1256 contracts gain for any carryback
year without regard to the net section 1256 contracts loss for the
loss year or any later tax year.
Traders in section 1256 contracts.
Gain or loss from the trading of section 1256 contracts is capital
gain or loss subject to the marked to market rules. However, this does
not apply to contracts held for purposes of hedging property if any
loss from the property would be an ordinary loss.
Treatment of underlying property.
The determination of whether an individual's gain or loss from any
property is ordinary or capital gain or loss is made without regard to
the fact that the individual is actively engaged in dealing in or
trading section 1256 contracts related to that property.
How To Report
If you disposed of regulated futures or foreign currency contracts
in 2000 (or had unrealized profit or loss on these contracts that were
open at the end of 1999 or 2000), you should receive Form
1099-B, or an equivalent statement, from your broker.
Form 6781.
Use Part I of Form 6781, Gains and Losses From Section 1256
Contracts and Straddles, to report your gains and losses from
all section 1256 contracts that are open at the end of the year or
that were closed out during the year. This includes the amount shown
in box 9 of Form 1099-B. Then enter the net amount of these
gains and losses on Schedule D (Form 1040). Include a copy of Form
6781 with your income tax return.
If the Form 1099-B you receive includes a straddle or hedging
transaction, defined later, it may be necessary to show certain
adjustments on Form 6781. Follow the Form 6781 instructions for
completing Part I.
Loss carryback election.
To carry back your loss under the election procedures described
earlier, file Form 1040X or appropriate amended return for the year to
which you are carrying the loss with an amended Form 6781 attached.
Follow the instructions for completing Form 6781 for the loss year to
make this election.
Hedging Transactions
The marked to market rules, described earlier, do not apply to
hedging transactions. A transaction is a hedging transaction if both
of the following conditions are met.
- You entered into the transaction in the normal course of
your trade or business primarily to manage the risk of:
- Price changes or currency fluctuations on ordinary property
you hold (or will hold), or
- Interest rate or price changes, or currency fluctuations, on
your current or future borrowings or ordinary obligations.
- You clearly identified the transaction as being a hedging
transaction before the close of the day on which you entered into
it.
This hedging transaction exception does not apply to
transactions entered into by or for any syndicate. A syndicate
is a partnership, S corporation, or other entity (other than a regular
corporation) that allocates more than 35% of its losses to limited
partners or limited entrepreneurs. A limited entrepreneur
is a person who has an interest in an enterprise (but not as a limited
partner) and who does not actively participate in its management.
However, an interest is not considered held by a limited partner or
entrepreneur if the interest holder actively participates (or did so
for at least 5 full years) in the management of the entity, or is the
spouse, child (including a legally adopted child), grandchild, or
parent of an individual who actively participates in the management of
the entity.
Hedging loss limit.
If you are a limited partner or entrepreneur in a syndicate, the
amount of a hedging loss you can claim is limited. A "hedging loss"
is the amount by which the allowable deductions in a tax year that
resulted from a hedging transaction (determined without regard to the
limit) are more than the income received or accrued during the tax
year from this transaction.
Any hedging loss that is allocated to you for the tax year is
limited to your taxable income for that year from the trade or
business in which the hedging transaction occurred. Ignore any hedging
transaction items in determining this taxable income. If you have a
hedging loss that is disallowed because of this limit, you can carry
it over to the next tax year as a deduction resulting from a hedging
transaction.
If the hedging transaction relates to property other than stock or
securities, the limit on hedging losses applies if the limited partner
or entrepreneur is an individual.
The limit on hedging losses does not apply to any hedging loss to
the extent that it is more than all your unrecognized gains from
hedging transactions at the end of the tax year that are from the
trade or business in which the hedging transaction occurred. The term
"unrecognized gain" has the same meaning as defined under
Straddles, later.
Sale of property used in a hedge.
Once you identify personal property as being part of a hedging
transaction, you must treat gain from its sale or exchange as ordinary
income, not capital gain.
Self-Employment Income
Gains and losses derived in the ordinary course of a commodity or
option dealer's trading in section 1256 contracts and property related
to these contracts are included in net earnings from self-employment.
In addition, the rules relating to contributions to self-employment
retirement plans apply. For information on retirement plan
contributions, see chapter 3 of Publication 535,
Business
Expenses, Publication 560,
Retirement Plans for Small
Business, and Publication 590,
Individual Retirement
Arrangements (IRAs).
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