Publication 550 |
2000 Tax Year |
Capital Gains & Losses
Words you may need to know (see Glossary):
- Call
- Commodity future
- Conversion transaction
- Forward contract
- Limited partner
- Listed option
- Nonequity option
- Options dealer
- Put
- Regulated futures contract
- Section 1256 contract
- Straddle
- Wash sale
This section discusses the tax treatment of gains and losses from
different types of investment transactions.
Character of gain or loss.
You need to classify your gains and losses as either ordinary or
capital gains or losses. You then need to classify your capital gains
and losses as either short term or long term. If you have long-term
gains and losses, you must identify your 28% rate gains and losses. If
you have a net capital gain, you must also identify any unrecaptured
section 1250 gain.
The correct classification and identification helps you figure the
limit on capital losses and the correct tax on capital gains. For
information about determining whether your capital gain or loss is
short term or long term, see Holding Period, later. For
information about whether your long-term gain or loss is a 28% rate
gain or loss and about unrecaptured section 1250 gain, see
Reporting Capital Gains and Losses and Capital Gains
Tax Rates, later.
Capital or Ordinary
Gain or Loss
If you have a taxable gain or a deductible loss from a transaction,
it may be either a capital gain or loss or an ordinary gain or loss,
depending on the circumstances. Generally, a sale or trade of a
capital asset (defined next) results in a capital gain or loss. A sale
or trade of a noncapital asset generally results in ordinary gain or
loss. Depending on the circumstances, a gain or loss on a sale or
trade of property used in a trade or business may be treated as either
capital or ordinary, as explained in Publication 544.
In some
situations, part of your gain or loss may be a capital gain or loss,
and part may be an ordinary gain or loss.
Capital Assets and
Noncapital Assets
For the most part, everything you own and use for personal
purposes, pleasure, or investment is a capital asset. Some
examples are:
- Stocks or bonds held in your personal account,
- A house owned and used by you and your family,
- Household furnishings,
- A car used for pleasure or commuting,
- Coin or stamp collections,
- Gems and jewelry, and
- Gold, silver, or any other metal.
Any property you own is a capital asset, except the following
noncapital assets.
- Property held mainly for sale to customers or
property that will physically become a part of the merchandise that is
for sale to customers.
- Depreciable property used in your trade or
business, even if fully depreciated.
- Real property used in your trade or
business.
- A copyright, a literary, musical, or artistic
composition, a letter or memorandum, or similar property --
- Created by your personal efforts,
- Prepared or produced for you (in the case of a letter,
memorandum, or similar property), or
- Acquired under circumstances (for example, by gift)
entitling you to the basis of the person who created the property or
for whom it was prepared or produced.
- Accounts or notes receivable acquired in the
ordinary course of a trade or business for services rendered or from
the sale of any of the properties described in (1).
- U.S. Government publications that you received
from the government free or for less than the normal sales price, or
that you acquired under circumstances entitling you to the basis of
someone who received the publications free or for less than the normal
sales price.
- Certain commodities derivative financial instruments
held, acquired, or entered into by commodities derivatives
dealers after December 16, 1999. For more information, see section
1221 of the Internal Revenue Code.
- Hedging transactions entered into after December
16, 1999, but only if the transaction is clearly identified as a
hedging transaction before the close of the day on which it was
acquired, originated, or entered into. For more information, see the
definition of "hedging transaction" earlier, and the discussion
of hedging transactions under Commodity Futures,
later.
- Supplies of a type you regularly use or consume
in the ordinary course of your trade or business, that you held or
acquired after December 16, 1999.
Investment property.
Investment property is a capital asset. Any gain or loss from its
sale or trade generally is a capital gain or loss.
Gold, silver, stamps, coins, gems, etc.
These are capital assets except when they are held for sale by a
dealer. Any gain or loss from their sale or trade generally is a
capital gain or loss.
Stocks, stock rights, and bonds.
All of these, including stock received as a dividend, are capital
assets except when they are held for sale by a securities dealer.
However, see Losses on Section 1244 (Small Business) Stock
and Losses on Small Business Investment Company Stock,
later.
Personal use property.
Property held for personal use only, rather than for investment, is
a capital asset, and you must report a gain from its sale as a capital
gain. However, you cannot deduct a loss from selling personal use
property.
Discounted Debt Instruments
Treat your gain or loss on the sale, redemption, or retirement of a
bond or other debt instrument originally issued at a discount or
bought at a discount as capital gain or loss, except as explained in
the following discussions.
Short-term government obligations.
Treat gains on short-term federal, state, or local government
obligations (other than tax-exempt obligations) as ordinary income up
to your ratable share of the acquisition discount. This treatment
applies to obligations that have a fixed maturity date not more than 1
year from the date of issue. Acquisition discount is the
stated redemption price at maturity minus your basis in the
obligation.
However, do not treat these gains as income to the extent you
previously included the discount in income. See Discount on
Short-Term Obligations in chapter 1
for more information.
Short-term nongovernment obligations.
Treat gains on short-term nongovernment obligations as ordinary
income up to your ratable share of OID. This treatment applies to
obligations that have a fixed maturity date of not more than 1 year
from the date of issue.
However, to the extent you previously included the discount in
income, you do not have to include it in income again. See
Discount on Short-Term Obligations, in chapter 1,
for more
information.
Tax-exempt state and local government bonds.
If these bonds were originally issued at a discount before
September 4, 1982, or you acquired them before March 2, 1984, treat
your part of the OID as tax-exempt interest. To figure your gain or
loss on the sale or trade of these bonds, reduce the amount realized
by your part of the OID.
If the bonds were issued after September 3, 1982, and acquired
after March 1, 1984, increase the adjusted basis by your part of the
OID to figure gain or loss. For more information on the basis of these
bonds, see Discounted tax-exempt obligations under
Stocks and Bonds, earlier in this chapter. Any gain from market discount is usually taxable on disposition or
redemption of tax-exempt bonds. If you bought the bonds before May 1,
1993, the gain from market discount is capital gain. If you bought the
bonds after April 30, 1993, the gain from market discount is ordinary
income.
You figure market discount by subtracting the price you paid for
the bond from the sum of the original issue price of the bond and the
amount of accumulated OID from the date of issue that represented
interest to any earlier holders. For more information, see Market
Discount Bonds in chapter 1.
A loss on the sale or other disposition of a tax-exempt state or
local government bond is deductible as a capital loss.
Redeemed before maturity.
If a state or local bond that was issued before June 9,
1980, is redeemed before it matures, the OID is not taxable to
you.
If a state or local bond issued after June 8, 1980, is
redeemed before it matures, the part of the OID that is earned while
you hold the bond is not taxable to you. However, you must report the
unearned part of the OID as a capital gain.
Example.
On July 1, 1989, the date of issue, you bought a 20-year, 6%
municipal bond for $800. The face amount of the bond was $1,000. The
$200 discount was OID. At the time the bond was issued, the issuer had
no intention of redeeming it before it matured. The bond was callable
at its face amount beginning 10 years after the issue date.
The issuer redeemed the bond at the end of 11 years (July 1, 2000)
for its face amount of $1,000 plus accrued annual interest of $60. The
OID earned during the time you held the bond, $73, is not taxable. The
$60 accrued annual interest also is not taxable. However, you must
report the unearned part of the OID ($127) as a capital gain.
Long-term debt instruments issued after 1954 and before May
28, 1969 (or before July 2, 1982, if a government instrument).
If you sell, trade, or redeem for a gain one of these debt
instruments, the part of your gain that is not more than your ratable
share of the OID at the time of sale or redemption is ordinary income.
The rest of the gain is capital gain. If, however, there was an
intention to call the debt instrument before maturity, all of your
gain that is not more than the entire OID is treated as ordinary
income at the time of the sale. This treatment of taxable gain also
applies to corporate instruments issued after May 27, 1969, under a
written commitment that was binding on May 27, 1969, and at all times
thereafter.
Example 1.
You bought a 30-year, 6% government bond for $700 at original issue
on April 1, 1982, and sold it for $800 on April 20, 2000. The
redemption price is $1,000. At the time of original issue, there was
no intention to call the bond before maturity. You have held the bond
for 216 full months. Do not count the additional days that are less
than a full month. The number of complete months from date of issue to
date of maturity is 360 (30 years). The fraction 216/360 multiplied by
the discount of $300 ($1,000 - $700) is equal to $180. This is
your ratable share of OID for the period you owned the bond. You must
treat any part of the gain up to $180 as ordinary income. As a result,
your $100 gain is treated as ordinary income.
Example 2.
If, in Example 1, you sold the bond for $900, you would
have a gain of $200. Of that amount, $180 is ordinary income and $20
is long-term capital gain.
Long-term debt instruments issued after May 27, 1969 (or
after July 1, 1982, if a government instrument).
If you hold one of these debt instruments, you must include a part
of the OID in your gross income each year that you own the instrument.
Your basis in that debt instrument is increased by the amount of OID
that you have included in your gross income. See Original Issue
Discount (OID) in chapter 1.
If you sell or trade the debt instrument before maturity, your gain
is a capital gain. However, if at the time the instrument was
originally issued there was an intention to call it before its
maturity, your gain generally is ordinary income to the extent of the
entire OID reduced by any amounts of OID previously includible in your
income. In this case, the rest of the gain is a capital gain.
An intention to call a debt instrument before maturity means there
is a written or oral agreement or understanding not provided for in
the debt instrument between the issuer and original holder that the
issuer will redeem the debt instrument before maturity. In the case of
debt instruments that are part of an issue, the agreement or
understanding must be between the issuer and the original holders of a
substantial amount of the debt instruments in the issue.
Example 1.
On February 4, 1998, you bought at original issue for $7,600, Jones
Corporation's 10-year, 5% bond which has a stated redemption price at
maturity of $10,000. On February 3, 2000, you sold the bond to Susan
Green for $9,040. Assume you have included $334 of the OID in your
gross income and increased your basis in the bond by that amount. This
includes the amount accrued for 2000. Your basis is now $7,934. If at
the time of the original issue there was no intention to call the bond
before maturity, your gain of $1,106 ($9,040 amount realized minus
$7,934 adjusted basis) is a long-term capital gain.
Example 2.
If, in Example 1, at the time of original issue there
was an intention to call the bond before maturity, your entire gain is
ordinary income. You figure this as follows:
1) |
Entire OID ($10,000 stated redemption price at
maturity minus $7,600 issue price) |
$2,400 |
2) |
Minus: Amount previously included
in income |
334 |
3) |
Maximum amount of ordinary income |
$2,066 |
Because the amount in (3) is more than your gain of $1,106,
your entire gain is ordinary income.
Market discount bonds.
If the debt instrument has market discount and you chose to include
the discount in income as it accrued, increase your basis in the debt
instrument by the accrued discount to figure capital gain or loss on
its disposition. If you did not choose to include the discount in
income as it accrued, you must report gain as ordinary interest income
up to the instrument's accrued market discount. See Market
Discount Bonds in chapter 1.
The rest of the gain is capital
gain.
However, a different rule applies if you dispose of a market
discount bond that was:
- Issued before July 19, 1984, and
- Purchased by you before May 1, 1993.
In that case, any gain is treated as interest income up to the
amount of your deferred interest deduction for the year you dispose of
the bond. The rest of the gain is capital gain. (Deferred interest
deduction for market discount bonds is discussed in chapter 3
under
When To Deduct Investment Interest.)
Report the sale or trade of a market discount bond on Schedule D
(Form 1040), line 1 or line 8. If the sale or trade results in a gain
and you did not choose to include market discount in income currently,
enter "Accrued Market Discount" on the next line in column (a)
and the amount of the accrued market discount as a loss in column (f).
Also report the amount of accrued market discount in column (f) as
interest income on Schedule B (Form 1040), line 1, and identify it as
"Accrued Market Discount."
Retirement of debt instrument.
Any amount that you receive on the retirement of a debt instrument
is treated in the same way as if you had sold or traded that
instrument.
Notes of individuals.
If you hold an obligation of an individual that was issued with OID
after March 1, 1984, you generally must include the OID in your income
currently, and your gain or loss on its sale or retirement is
generally capital gain or loss. An exception to this treatment applies
if the obligation is a loan between individuals and all of the
following requirements are met.
- The lender is not in the business of lending money.
- The amount of the loan, plus the amount of any outstanding
prior loans, is $10,000 or less.
- Avoiding federal tax is not one of the principal purposes of
the loan.
If the exception applies, or the obligation was issued before March
2, 1984, you do not include the OID in your income currently. When you
sell or redeem the obligation, the part of your gain that is not more
than your accrued share of the OID at that time is ordinary income.
The rest of the gain, if any, is capital gain. Any loss on the sale or
redemption is capital loss.
Bearer Obligations
You cannot deduct any loss on an obligation required to be in
registered form that is instead held in bearer form. In addition, any
gain on the sale or other disposition of the obligation is ordinary
income. However, if the issuer was subject to a tax when the
obligation was issued, then you can deduct any loss, and any gain may
qualify for capital gain treatment.
Obligations required to be in registered form.
Any obligation must be in registered form unless:
- It is issued by a natural person,
- It is not of a type offered to the public,
- It has a maturity at the date of issue of not more than 1
year, or
- It was issued before 1983.
Deposit in Insolvent or
Bankrupt Financial Institution
If you lose money you have on deposit in a qualified financial
institution that becomes insolvent or bankrupt, you may be able to
deduct your loss in one of three ways.
- Ordinary loss,
- Casualty loss, or
- Nonbusiness bad debt (short-term capital loss).
Ordinary loss or casualty loss.
If you can reasonably estimate your loss, you can choose to treat
the estimated loss as either an ordinary loss or a casualty loss in
the current year. Either way, you claim the loss as an itemized
deduction.
If you claim an ordinary loss, report it as a miscellaneous
itemized deduction on line 22 of Schedule A (Form 1040). The maximum
amount you can claim is $20,000 ($10,000 if you are married filing
separately) reduced by any expected state insurance proceeds. Your
loss is subject to the 2%-of-adjusted-gross- income limit. You cannot
choose to claim an ordinary loss if any part of the deposit is
federally insured.
If you claim a casualty loss, attach Form 4684,
Casualties and Thefts, to your return. Each loss must
be reduced by $100. Your total casualty losses for the year are
reduced by 10% of your adjusted gross income.
You cannot choose either of these methods if:
- You own at least 1% of the financial institution,
- You are an officer of the institution, or
- You are related to such an owner or officer. You are related
if you and the owner or officer are "related parties," as defined
earlier under Related Party Transactions, or if you are the
aunt, uncle, nephew, or niece of the owner or officer.
If the actual loss that is finally determined is more than the
amount you deducted as an estimated loss, you can claim the excess
loss as a bad debt. If the actual loss is less than the amount
deducted as an estimated loss, you must include in income (in the
final determination year) the excess loss claimed. See
Recoveries, in Publication 525,
Taxable and Nontaxable
Income.
Nonbusiness bad debt.
If you do not choose to deduct your estimated loss as a casualty
loss or an ordinary loss, you wait until the year the amount of the
actual loss is determined and deduct it as a nonbusiness bad debt in
that year. Report it as a short-term capital loss on Schedule D (Form
1040), as explained under Nonbusiness Bad Debts, later.
Sale of Annuity
The part of any gain on the sale of an annuity contract before its
maturity date that is based on interest accumulated on the contract is
ordinary income.
Conversion Transactions
Generally, all or part of a gain on a conversion transaction is
treated as ordinary income. This applies to gain on the disposition or
other termination of any position you held as part of a conversion
transaction that you entered into after April 30, 1993.
A conversion transaction is any transaction that meets both of
these tests.
- Substantially all of your expected return from the
transaction is due to the time value of your net investment. In other
words, the return on your investment is, in substance, like interest
on a loan.
- The transaction is one of the following.
- A straddle as defined under Straddles, later, but
including any set of offsetting positions on stock.
- Any transaction in which you acquire property (whether or
not actively traded) at substantially the same time that you contract
to sell the same property, or substantially identical property, at a
price set in the contract.
- Any other transaction that is marketed or sold as producing
capital gains from a transaction described in (1).
Amount treated as ordinary income.
The amount of gain treated as ordinary income is the smaller of:
- The gain recognized on the disposition or other termination
of the position, or
- The "applicable imputed income amount."
Applicable imputed income amount.
Figure this amount as follows.
- Figure the amount of interest that would have accrued on
your net investment in the conversion transaction for the period
ending on the earlier of:
- The date when you dispose of the position, or
- The date when the transaction stops being a conversion
transaction.
To figure this amount, use an interest rate equal to 120% of the
"applicable rate," defined later.
- Subtract from (1) the amount treated as ordinary income from
any earlier disposition or other termination of a position held as
part of the same conversion transaction.
Applicable rate.
If the term of the conversion transaction is indefinite, the
applicable rate is the federal short-term rate in effect under section
6621(b) of the Internal Revenue Code during the period of the
conversion transaction, compounded daily.
In all other cases, the applicable rate is the "applicable
federal rate" determined as if the conversion transaction were a
debt instrument and compounded semi-annually.
The rates discussed above are published by the IRS in the
Internal Revenue Bulletin. Or, you can contact the IRS to
get these rates. See chapter 5
for the number to call.
Net investment.
To determine your net investment in a conversion transaction,
include the fair market value of any position at the time it becomes
part of the transaction. This means that your net investment generally
will be the total amount you invested, less any amount you received
for entering into the position (for example, a premium you received
for writing a call).
Position with built-in loss.
A special rule applies when a position with a built-in loss becomes
part of a conversion transaction. A built-in loss is any loss that you
would have realized if you had disposed of or otherwise terminated the
position at its fair market value at the time it became part of the
conversion transaction.
When applying the conversion transaction rules to a position with a
built-in loss, use the position's fair market value at the time it
became part of the transaction. But, when you dispose of or otherwise
terminate the position in a transaction in which you recognize gain or
loss, you must recognize the built-in loss. The conversion transaction
rules do not affect whether the built-in loss is treated as an
ordinary or capital loss.
Netting rule for certain conversion transactions.
Before determining the amount of gain treated as ordinary income,
you can net certain gains and losses from positions of the same
conversion transaction. To do this, you have to dispose of all the
positions within a 14-day period that is within a single tax year. You
cannot net the built-in loss against the gain.
You can net gains and losses only if you identify the conversion
transaction as an identified netting transaction on your books and
records. Each position of the conversion transaction must be
identified before the end of the day on which the position becomes
part of the conversion transaction. For conversion transactions
entered into before February 20, 1996, this requirement is met if the
identification was made by that date.
Options dealers and commodities traders.
Special rules apply to options dealers and commodities traders. See
section 1258(d)(5) of the Internal Revenue Code.
How to report.
Use Form 6781, Gains and Losses From Section 1256 Contracts
and Straddles, to report conversion transactions. See the
instructions for lines 11 and 13 of Form 6781.
Commodity Futures
A commodity futures contract is a standardized, exchange-traded
contract for the sale or purchase of a fixed amount of a commodity at
a future date for a fixed price.
If the contract is a regulated futures contract, the rules
described earlier under Section 1256 Contracts Marked To Market,
apply to it.
The termination of a commodity futures contract generally results
in capital gain or loss unless the contract is a hedging transaction.
Hedging transaction.
A futures contract that is a hedging transaction generally
produces ordinary gain or loss. A futures contract is a hedging
transaction if you enter into the contract in the ordinary course of
your business primarily to manage the risk of interest rate or price
changes or currency fluctuations on borrowings, ordinary property, or
ordinary obligations. (Generally, ordinary property or obligations are
those that cannot produce capital gain or loss under any
circumstances.) For example, the offset or exercise of a futures
contract that protects against price changes in your business
inventory results in an ordinary gain or loss.
For more information about hedging transactions, see section
1.1221-2 of the regulations. Also, see Hedging
Transactions under Section 1256 Contracts Marked to
Market, earlier.
If you have numerous transactions in the commodity futures market
during the year, the burden of proof is on you to show which
transactions are hedging transactions. Clearly identify any hedging
transactions on your books and records before the end of the day you
entered into the transaction. It may be helpful to have separate
brokerage accounts for your hedging and nonhedging transactions. For
specific requirements concerning identification of hedging
transactions and the underlying item, items, or aggregate risk that is
being hedged, see section 1.1221-2(e) of the regulations.
Gains From Certain Constructive Ownership Transactions
If you have a gain from a constructive ownership transaction
entered into after July 11, 1999, involving a financial asset
(discussed later) and the gain normally would be treated as long-term
capital gain, all or part of the gain may be treated instead as
ordinary income. In addition, if any gain is treated as ordinary
income, your tax is increased by an interest charge.
Constructive ownership transactions.
The following are constructive ownership transactions.
- A notional principal contract (discussed below) in which you
have the right to receive substantially all of the investment yield on
a financial asset and you are obligated to reimburse substantially all
of any decline in value of the financial asset.
- A forward or futures contract to acquire a financial
asset.
- The holding of a call option and writing of a put option on
a financial asset at substantially the same strike price and maturity
date.
This provision does not apply if all the positions are marked to
market. Marked to market rules for section 1256 contracts are
discussed in detail under Section 1256 Contracts Marked to
Market, earlier.
Financial asset.
A financial asset, for this purpose, is any equity interest in a
pass-through entity. Pass-through entities include partnerships, S
corporations, trusts, regulated investment companies, and real estate
investment trusts.
Amount of ordinary income.
Long-term capital gain is treated as ordinary income to the extent
it is more than the net underlying long-term capital gain.
The net underlying long-term capital gain is the amount of net
capital gain you would have realized if you acquired the asset for its
fair market value on the date the constructive ownership transaction
was opened, and sold the asset for its fair market value on the date
the transaction was closed. If you do not establish the amount of net
underlying long-term capital gain by clear and convincing evidence, it
is treated as zero.
More information.
For more information, see section 1260 of the Internal Revenue
Code.
Losses on Section 1244
(Small Business) Stock
You can deduct as an ordinary loss, rather than as a capital loss,
a loss on the sale, trade, or worthlessness of section 1244 stock.
Report the loss on Form 4797, Sales of Business
Property, line 10.
Any gain on section 1244 stock is a capital gain if the stock is a
capital asset in your hands. Do not offset gains against losses that
are within the ordinary loss limit, explained later in this
discussion, even if the transactions are in stock of the same company.
Report the gain on Schedule D of Form 1040.
If you must figure a net operating loss, any ordinary loss from the
sale of section 1244 stock is a business loss.
Ordinary loss limit.
The amount that you can deduct as an ordinary loss is limited to
$50,000 each year. On a joint return the limit is $100,000, even if
only one spouse has this type of loss. If your loss is $110,000 and
your spouse has no loss, you can deduct $100,000 as an ordinary loss
on a joint return. The remaining $10,000 is a capital loss.
Section 1244 (small business) stock.
This is stock that was issued for money or property (other than
stock and securities) in a domestic small business corporation. During
its 5 most recent tax years before the loss, this corporation must
have derived more than 50% of its gross receipts from other than
royalties, rents, dividends, interest, annuities, and gains from sales
and trades of stocks or securities. If the corporation was in
existence for at least 1 year, but less than 5 years, the 50% test
applies to the tax years ending before the loss. If the corporation
was in existence less than 1 year, the 50% test applies to the entire
period the corporation was in existence before the day of the loss.
However, if the corporation's deductions (other than the net operating
loss and dividends received deductions) were more than its gross
income during this period, this 50% test does not apply.
The corporation must have been largely an operating company for
ordinary loss treatment to apply.
If the stock was issued before July 19, 1984, the stock must be
common stock. If issued after July 18, 1984, the stock may be either
common or preferred. For more information about the requirements of a
small business corporation or the qualifications of section 1244
stock, see section 1244 of the Internal Revenue Code and its
regulations.
The stock must be issued to the person taking the loss.
You must be the original owner of the stock to be allowed ordinary
loss treatment. To claim a deductible loss on stock issued to your
partnership, you must have been a partner when the stock was issued
and have remained so until the time of the loss. You add your
distributive share of the partnership loss to any individual section
1244 stock loss you may have before applying the ordinary loss limit.
Stock distributed by partnership.
If your partnership distributes the stock to you, you cannot treat
any later loss on that stock as an ordinary loss.
Stock sold through underwriter.
Stock sold through an underwriter is not section 1244 stock unless
the underwriter only acted as a selling agent for the corporation.
Stock dividends and reorganizations.
Stock you receive as a stock dividend qualifies as section 1244
stock if:
- You receive it from a small business corporation in which
you own stock, and
- The stock you own meets the requirements when the stock
dividend is distributed.
If you trade your section 1244 stock for new stock in the same
corporation in a reorganization that qualifies as a recapitalization
or that is only a change in identity, form, or place of organization,
the new stock is section 1244 stock if the stock you trade meets the
requirements when the trade occurs.
If you hold section 1244 stock and other stock in the same
corporation, not all of the stock you receive as a stock dividend or
in a reorganization will qualify as section 1244 stock. Only that part
based on the section 1244 stock you hold will qualify.
Example.
Your basis for 100 shares of X common stock is $1,000. These shares
qualify as section 1244 stock. If, as a nontaxable stock dividend, you
receive 50 more shares of common stock, the basis of which is
determined from the 100 shares you own, the 50 shares are also section
1244 stock.
If you also own stock in the corporation that is not section 1244
stock when you receive the stock dividend, you must divide the shares
you receive as a dividend between the section 1244 stock and the other
stock. Only the shares from the former can be section 1244 stock.
Contributed property.
To determine ordinary loss on section 1244 stock you receive in a
trade for property, you have to reduce the basis of the stock if:
- The adjusted basis (for figuring loss) of the property,
immediately before the trade, was more than its fair market value, and
- The basis of the stock is determined by the basis of the
property.
Reduce the basis of the stock by the difference between the
adjusted basis of the property and its fair market value at the time
of the trade. You reduce the basis only to figure the ordinary loss.
Do not reduce the basis of the stock for any other purpose.
Example.
You transfer property with an adjusted basis of $1,000 and a fair
market value of $250 to a corporation for its section 1244 stock. The
basis of your stock is $1,000, but to figure the ordinary loss under
these rules, the basis of your stock is $250 ($1,000 minus $750). If
you later sell the section 1244 stock for $200, your $800 loss is an
ordinary loss of $50 and a capital loss of $750.
Contributions to capital.
If the basis of your section 1244 stock has increased, through
contributions to capital or otherwise, you must treat this increase as
applying to stock that is not section 1244 stock when you figure an
ordinary loss on its sale.
Example.
You buy 100 shares of section 1244 stock for $10,000. You are the
original owner. You later make a $2,000 contribution to capital that
increases the total basis of the 100 shares to $12,000. You then sell
the 100 shares for $9,000 and have a loss of $3,000. You can deduct
only $2,500 ($3,000 x $10,000/$12,000) as an ordinary loss under
these rules. The remaining $500 is a capital loss.
Recordkeeping.
You must keep records
sufficient to show your stock qualifies as section 1244 stock. Your
records must also distinguish your section 1244 stock from any other
stock you own in the corporation.
Losses on Small Business Investment Company Stock
A small business investment company (SBIC) is one that is licensed
and operated under the Small Business Investment Act of 1958.
If you are an investor in SBIC stock, you can deduct as an ordinary
loss, rather than a capital loss, a loss from the sale, trade, or
worthlessness of that stock. A gain from the sale or trade of that
stock is a capital gain. Do not offset your gains and losses, even if
they are on stock of the same company.
How to report.
You report this type of ordinary loss on line 10, Part II, of Form
4797. In addition to the information required by the form, you must
include the name and address of the company that issued the stock.
Report a capital gain from the sale of SBIC stock on Schedule D of
Form 1040.
Short sale.
If you close a short sale of SBIC stock
with other SBIC stock that you
bought only for that purpose, any loss you have on the sale is a
capital loss. See Short Sales, later in this chapter, for
more information.
Holding Period
If you sold or traded investment property, you must determine your
holding period for the property. Your holding period determines
whether any capital gain or loss was a short-term or a long-term
capital gain or loss.
Long-term or short-term.
If you hold investment property more than 1 year, any
capital gain or loss is a long-term capital gain or loss.
If you hold the property 1 year or less, any capital gain
or loss is a short-term capital gain or loss.
To determine how long you held the investment property, begin
counting on the date after the day you acquired the property. The day
you disposed of the property is part of your holding period.
Example.
If you bought investment property on February 5, 1999, and sold it
on February 5, 2000, your holding period is not more than 1 year and
you have a short-term capital gain or loss. If you sold it on February
6, 2000, your holding period is more than 1 year and you have a
long-term capital gain or loss.
Securities traded on an established market.
For securities traded on an established securities market, your
holding period begins the day after the trade date you
bought the securities, and ends on the trade date you sold them.
Do not confuse the trade date with the settlement date, which is
the date by which the stock must be delivered and payment must be
made.
Example.
You are a cash method, calendar year taxpayer. You sold stock at a
gain on December 29, 2000. According to the rules of the stock
exchange, the sale was closed by delivery of the stock 3 trading days
after the sale, on January 4, 2001. You received payment of the sale
price on that same day. Report your gain on your 2000 return, even
though you received the payment in 2001. The gain is long term or
short term depending on whether you held the stock more than 1 year.
Your holding period ended on December 29. If you had sold the stock at
a loss, you would also report it on your 2000 return.
U.S. Treasury notes and bonds.
The holding period of U.S. Treasury notes and bonds sold at auction
on the basis of yield starts the day after the Secretary of the
Treasury, through news releases, gives notification of acceptance to
successful bidders. The holding period of U.S. Treasury notes and
bonds sold through an offering on a subscription basis at a specified
yield starts the day after the subscription is submitted.
Automatic investment service.
In determining your holding period for shares bought by the bank or
other agent, full shares are considered bought first and any
fractional shares are considered bought last. Your holding period
starts on the day after the bank's purchase date. If a share was
bought over more than one purchase date, your holding period for that
share is a split holding period. A part of the share is considered to
have been bought on each date that stock was bought by the bank with
the proceeds of available funds.
Nontaxable trades.
If you acquire investment property in a trade for other investment
property and your basis for the new property is determined, in whole
or in part, by your basis in the old property, your holding period for
the new property begins on the day following the date you acquired the
old property.
Property received as a gift.
If you receive a gift of property and your basis is determined by
the donor's adjusted basis, your holding period is considered to have
started on the same day the donor's holding period started.
If your basis is determined by the fair market value of the
property, your holding period starts on the day after the date of the
gift.
Inherited property.
If you inherit investment property, your capital gain or loss on
any later disposition of that property is treated as a long-term
capital gain or loss. This is true regardless of how long you actually
held the property.
Real property bought.
To figure how long you have held real property bought under an
unconditional contract, begin counting on the day after you received
title to it or on the day after you took possession of it and assumed
the burdens and privileges of ownership, whichever happened first.
However, taking delivery or possession of real property under an
option agreement is not enough to start the holding period. The
holding period cannot start until there is an actual contract of sale.
The holding period of the seller cannot end before that time.
Real property repossessed.
If you sell real property but keep a security interest in it, and
then later repossess the property under the terms of the sales
contract, your holding period for a later sale includes the period you
held the property before the original sale and the period after the
repossession. Your holding period does not include the time between
the original sale and the repossession. That is, it does not include
the period during which the first buyer held the property.
Stock dividends.
The holding period for stock you received as a taxable stock
dividend begins on the date of distribution.
The holding period for new stock you received as a nontaxable stock
dividend begins on the same day as the holding period of the old
stock. This rule also applies to stock acquired in a spin-off,
which is a distribution of stock or securities in a controlled
corporation.
Nontaxable stock rights.
Your holding period for nontaxable stock rights begins on the same
day as the holding period of the underlying stock. The holding period
for stock acquired through the exercise of stock rights begins on the
date the right was exercised.
Section 1256 contracts.
Gains or losses on section 1256 contracts open at the end of the
year, or terminated during the year, are treated as 60% long term and
40% short term, regardless of how long the contracts were held. See
Section 1256 Contracts Marked to Market, earlier.
Option property.
Your holding period for property you acquire when you exercise an
option begins the day after you exercise the option.
Wash sales.
Your holding period for substantially identical stock or securities
you acquire in a wash sale includes the period you held the old stock
or securities.
Qualified small business stock.
Your holding period for stock you acquired in a tax-free rollover
of gain from a sale of qualified small business stock, described
later, includes the period you held the old stock.
Commodity futures.
Futures transactions in any commodity subject to the rules of a
board of trade or commodity exchange are long term if the contract was
held for more than 6 months.
Your holding period for a commodity received in satisfaction of a
commodity futures contract, other than a regulated futures contract
subject to Internal Revenue Code section 1256, includes your holding
period for the futures contract if you held the contract as a capital
asset.
Loss on mutual fund or REIT stock held 6 months or less.
If you hold stock in a regulated investment company
(commonly called a mutual fund) or real estate
investment trust (REIT) for 6 months or less and then sell it at
a loss (other than under a periodic liquidation plan), special rules
may apply.
Capital gain distributions received.
The loss (after reduction for any exempt-interest dividends you
received, as explained next) is treated as a long-term capital loss up
to the total of any capital gain distributions you received and your
share of any undistributed capital gains. Any remaining loss is
short-term capital loss.
Exempt-interest dividends on mutual fund stock.
If you received exempt-interest dividends on the stock, at least
part of your loss is disallowed. You can deduct only the amount of
loss that is more than the exempt-interest dividends.
Nonbusiness Bad Debts
If someone owes you money that you cannot collect, you have a bad
debt. You may be able to deduct the amount owed to you when you figure
your tax for the year the debt becomes worthless.
There are two kinds of bad debts -- business and nonbusiness.
A business bad debt, generally, is one that comes from operating your
trade or business and is deductible as a business loss. All other bad
debts are nonbusiness bad debts and are deductible as short-term
capital losses.
Example.
An architect made personal loans to several friends who were not
clients. She could not collect on some of these loans. They are
deductible only as nonbusiness bad debts because the architect was not
in the business of lending money and the loans do not have any
relationship to her business.
Business bad debts.
For information on business bad debts of an employee, see
Publication 529.
For information on other business bad debts, see
chapter 11 of Publication 535.
Deductible nonbusiness bad debts.
To be deductible, nonbusiness bad debts must be totally worthless.
You cannot deduct a partly worthless nonbusiness debt.
Genuine debt required.
A debt must be genuine for you to deduct a loss. A debt is genuine
if it arises from a debtor-creditor relationship based on a valid and
enforceable obligation to repay a fixed or determinable sum of money.
Loan or gift.
For a bad debt, you must show that there was an intention at the
time of the transaction to make a loan and not a gift. If you lend
money to a relative or friend with the understanding that it may not
be repaid, it is considered a gift and not a loan. You cannot take a
bad debt deduction for a gift. There cannot be a bad debt unless there
is a true creditor-debtor relationship between you and the person or
organization that owes you the money.
When minor children borrow from their parents to pay for their
basic needs, there is no genuine debt. A bad debt cannot be deducted
for such a loan.
Basis in bad debt required.
To deduct a bad debt, you must have a basis in it -- that is,
you must have already included the amount in your income or loaned out
your cash. For example, you cannot claim a bad debt deduction for
court-ordered child support not paid to you by your former spouse. If
you are a cash method taxpayer (most individuals are), you generally
cannot take a bad debt deduction for unpaid salaries, wages, rents,
fees, interest, dividends, and similar items.
When deductible.
You can take a bad debt deduction only in the year the debt becomes
worthless. You do not have to wait until a debt is due to determine
whether it is worthless. A debt becomes worthless when there is no
longer any chance that the amount owed will be paid.
It is not necessary to go to court if you can show that a judgment
from the court would be uncollectible. You must only show that you
have taken reasonable steps to collect the debt. Bankruptcy of your
debtor is generally good evidence of the worthlessness of at least a
part of an unsecured and unpreferred debt.
If your bad debt is the loss of a deposit in a financial
institution, see Loss on deposits in an insolvent or bankrupt
financial institution, earlier.
Filing a claim for refund.
If you do not deduct a bad debt on your original return for the
year it becomes worthless, you can file a claim for a credit or refund
due to the bad debt. To do this, use Form 1040X to amend your return
for the year the debt 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 bad debts or worthless securities 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.
Loan guarantees.
If you guarantee a debt that becomes worthless, you cannot take a
bad debt deduction for your payments on the debt unless you can show
either that your reason for making the guarantee was to protect your
investment or that you entered the guarantee transaction with a profit
motive. If you make the guarantee as a favor to friends and do not
receive any consideration in return, your payments are considered a
gift and you cannot take a deduction.
Example 1.
Henry Lloyd, an officer and principal shareholder of the Spruce
Corporation, guaranteed payment of a bank loan the corporation
received. The corporation defaulted on the loan and Henry made full
payment. Because he guaranteed the loan to protect his investment in
the corporation, Henry can take a nonbusiness bad debt deduction.
Example 2.
Milt and John are co-workers. Milt, as a favor to John, guarantees
a note at their local credit union. John does not pay the note and
declares bankruptcy. Milt pays off the note. However, since he did not
enter into the guarantee agreement to protect an investment or to make
a profit, Milt cannot take a bad debt deduction.
Deductible in year paid.
Unless you have rights against the borrower, discussed next, a
payment you make on a loan you guaranteed is deductible in the year
you make the payment.
Rights against the borrower.
When you make payment on a loan that you guaranteed, you may have
the right to take the place of the lender (the right of subrogation).
The debt is then owed to you. If you have this right, or some other
right to demand payment from the borrower, you cannot take a bad debt
deduction until these rights become totally worthless.
Debts owed by political parties.
You cannot take a nonbusiness bad debt deduction for any worthless
debt owed to you by:
- A political party,
- A national, state, or local committee of a political party,
or
- A committee, association, or organization that either
accepts contributions or spends money to influence elections.
Mechanics' and suppliers' liens.
Workers and material suppliers may file liens against property
because of debts owed by a builder or contractor. If you pay off the
lien to avoid foreclosure and loss of your property, you are entitled
to repayment from the builder or contractor. If the debt is
uncollectible, you can take a bad debt deduction.
Insolvency of contractor.
You can take a bad debt deduction for the amount you deposit with a
contractor if the contractor becomes insolvent and you are unable to
recover your deposit. If the deposit is for work unrelated to your
trade or business, it is a nonbusiness bad debt deduction.
Secondary liability on home mortgage.
If the buyer of your home assumes your mortgage, you may remain
secondarily liable for repayment of the mortgage loan. If the buyer
defaults on the loan and the house is then sold for less than the
amount outstanding on the mortgage, you may have to make up the
difference. You can take a bad debt deduction for the amount you pay
to satisfy the mortgage, if you cannot collect it from the buyer.
Worthless securities.
If you own securities that become totally worthless, you can take a
deduction for a loss, but not for a bad debt. See Worthless
Securities under What Is a Sale or Trade, earlier in
this chapter. How to report bad debts.
Deduct nonbusiness bad debts as short-term capital losses on
Schedule D (Form 1040).
In Part I, line 1 of Schedule D, enter the name of the debtor and
"statement attached" in column (a). Enter the amount of the bad
debt in parentheses in column (f). Use a separate line for each bad
debt.
For each bad debt, attach a statement to your return that contains:
- A description of the debt, including the amount, and the
date it became due,
- The name of the debtor, and any business or family
relationship between you and the debtor,
- The efforts you made to collect the debt, and
- Why you decided the debt was worthless. For example, you
could show that the borrower has declared bankruptcy, or that legal
action to collect would probably not result in payment of any part of
the debt.
S corporation shareholder.
If you are a shareholder in an S corporation, your share of any
nonbusiness bad debt will be shown on a schedule attached to your
Schedule K-1 (Form 1120S) that you receive from the corporation.
Recovery of a bad debt.
If you deducted a bad debt and in a later tax year you recover
(collect) all or part of it, you may have to include the amount you
recover in your gross income. However, you can exclude from gross
income the amount recovered up to the amount of the deduction that did
not reduce your tax in the year deducted. See Recoveries in
Publication 525.
Short Sales
A short sale occurs when you agree to sell property you do not own
(or own but do not wish to sell). You make this type of sale in two
steps.
- You sell short. You borrow property and deliver
it to a buyer.
- You close the sale. At a later date, you either
buy substantially identical property and deliver it to the lender or
make delivery out of property that you held at the time of the sale.
You do not realize gain or loss until delivery of property to
close the short sale. You will have a capital gain or loss if the
property used to close the short sale is a capital asset.
Exception if property becomes worthless.
A different rule applies if the property sold short becomes
substantially worthless. In that case, you must recognize gain as if
the short sale were closed when the property became substantially
worthless.
Exception for constructive sales.
Entering into a short sale may cause you to be treated as having
made a constructive sale of property. In that case, you will have to
recognize gain on the date of the constructive sale. For details, see
Constructive Sales of Appreciated Financial Positions,
earlier.
Example.
On May 1, 2000, you bought 100 shares of Baker Corporation stock
for $1,000. On September 3, 2000, you sold short 100 shares of similar
Baker stock for $1,600. You made no other transactions involving Baker
stock for the rest of 2000 and the first 30 days of 2001. Your short
sale is treated as a constructive sale of an appreciated financial
position because a sale of your Baker stock on the date of the short
sale would have resulted in a gain. You recognize a $600 short-term
capital gain from the constructive sale and your new holding period in
the Baker stock begins on September 3.
Short-Term or Long-Term
Capital Gain or Loss
As a general rule, you determine whether you have short-term or
long-term capital gain or loss on a short sale by the amount of time
you actually hold the property eventually delivered to the lender to
close the short sale.
Example.
Even though you do not own any stock of the Ace Corporation, you
contract to sell 100 shares of it, which you borrow from your broker.
After 13 months, when the price of the stock has risen, you buy 100
shares of Ace Corporation stock and immediately deliver them to your
broker to close out the short sale. Your loss is a short-term capital
loss because your holding period for the delivered property is less
than one day.
Special rules.
Special rules may apply to short sales of stocks, securities, and
commodity futures (other than certain straddles). These rules limit
the circumstances for treating capital gain as long term and capital
loss as short term by taking into account certain substantially
identical property you held on the date of the short sale or acquired
afterwards. But if the amount of property you sold short is more than
the amount of that substantially identical property, the special rules
do not apply to the gain or loss on the excess.
Special rules for gains and holding period.
If you held the substantially identical property for 1 year or less
on the date of the short sale, or if you acquired the substantially
identical property after the short sale and by the date of closing the
short sale, then:
- Rule 1. Your gain, if any, when you close the
short sale is a short-term capital gain, and
- Rule 2. The holding period of the substantially
identical property begins on the date of the closing of the short sale
or on the date of the sale of this property, whichever comes first.
Special rule for treatment of losses.
If, on the date of the short sale, you held substantially identical
property for more than 1 year, any loss you realize on the short sale
is a long-term capital loss, even if you held the property used to
close the sale for 1 year or less. Certain losses on short sales of
stock or securities are also subject to wash sale treatment. For
information, see Wash Sales, later.
Mixed straddles.
Under certain elections, you can avoid the treatment of loss from a
short sale as long term under the special rule. These elections are
for positions that are part of a mixed straddle. See Other
elections under Mixed Straddles, later, for more
information about these elections.
Reporting Substitute Payments
If any broker transferred your securities for use in a short sale,
or similar transaction, and received certain substitute dividend
payments on your behalf while the short sale was open, that broker
must give you a Form 1099-MISC or a similar
statement, reporting the amount of these payments. Form
1099-MISC must be used for those substitute payments totaling
$10 or more that are known on the payment's record date to be in lieu
of an exempt-interest dividend, a capital gain dividend, a return of
capital distribution, or a dividend subject to a foreign tax credit,
or that are in lieu of tax-exempt interest. Do not treat these
substitute payments as dividends or interest. Instead, report the
substitute payments shown on Form 1099-MISC as "Other income"
on line 21 of Form 1040.
Substitute payment.
A substitute payment means a payment in lieu of:
- Tax-exempt interest (including OID) that has accrued while
the short sale was open, and
- A dividend, if the ex-dividend date is after the transfer of
stock for use in a short sale and before the closing of the short
sale.
Short Sale Expenses
If you borrow stock to make a short sale, you may have to remit to
the lender payments in lieu of the dividends distributed while you
maintain your short position. You can deduct these payments only if
you hold the short sale open at least 46 days (more than 1 year in the
case of an extraordinary dividend as defined below) and you itemize
your deductions.
You deduct these expenses as investment interest on Schedule A
(Form 1040). See Interest Expenses in chapter 3
for more
information.
If you close the short sale by the 45th day after the date of the
short sale (1 year or less in the case of an extraordinary dividend),
you cannot deduct the payment in lieu of the dividend that you make to
the lender. Instead, you must increase the basis of the stock used to
close the short sale by that amount.
To determine how long a short sale is kept open, do not include any
period during which you hold, have an option to buy, or are under a
contractual obligation to buy substantially identical stock or
securities.
If your payment is made for a liquidating distribution or
nontaxable stock distribution, or if you buy more shares equal to a
stock distribution issued on the borrowed stock during your short
position, you have a capital expense. You must add the payment to the
cost of the stock sold short.
Exception.
If you close the short sale within 45 days, the deduction for
amounts you pay in lieu of dividends will be disallowed only to the
extent the payments are more than the amount that you receive as
ordinary income from the lender of the stock for the use of collateral
with the short sale. This exception does not apply to payments in
place of extraordinary dividends.
Extraordinary dividends.
If the amount of any dividend you receive on a share of preferred
stock equals or exceeds 5% (10% in the case of other stock) of the
amount realized on the short sale, the dividend you receive is an
extraordinary dividend.
Wash Sales
You cannot deduct losses from sales or trades of stock or
securities in a wash sale.
A wash sale occurs when you sell or trade stock or securities at a
loss and within 30 days before or after the sale you:
- Buy substantially identical stock or securities,
- Acquire substantially identical stock or securities in a
fully taxable trade, or
- Acquire a contract or option to buy substantially identical
stock or securities.
If you sell stock and your spouse or a corporation you control
buys substantially identical stock, you also have a wash sale.
If your loss was disallowed because of the wash sale rules, add the
disallowed loss to the cost of the new stock or securities. The result
is your basis in the new stock or securities. This adjustment
postpones the loss deduction until the disposition of the new stock or
securities. Your holding period for the new stock or securities begins
on the same day as the holding period of the stock or securities sold.
Example 1.
You buy 100 shares of X stock for $1,000. You sell these shares for
$750 and within 30 days from the sale you buy 100 shares of the same
stock for $800. Because you bought substantially identical stock, you
cannot deduct your loss of $250 on the sale. However, you add the
disallowed loss ($250) to the cost of the new stock ($800) to obtain
your basis of the new stock, which is $1,050.
Example 2.
You are an employee of a corporation that has an incentive pay
plan. Under this plan, you are given 10 shares of the corporation's
stock as a bonus award. You include the fair market value of the stock
in your gross income as additional pay. You later sell these shares at
a loss. If you receive another bonus award of substantially identical
stock within 30 days of the sale, you cannot deduct your loss on the
sale.
Options and futures contracts.
The wash sale rules apply to losses from sales or trades of
contracts and options to acquire or sell stock or securities. They do
not apply to losses from sales or trades of commodity futures
contracts and foreign currencies. See Coordination of Loss
Deferral Rules and Wash Sale Rules under Straddles,
later, for information about the tax treatment of losses on the
disposition of positions in a straddle.
Warrants.
The wash sale rules apply if you sell common stock at a loss and,
at the same time, buy warrants for common stock of the same
corporation. But if you sell warrants at a loss and, at the same time,
buy common stock in the same corporation, the wash sale rules apply
only if the warrants and stock are considered substantially identical,
as discussed next.
Substantially identical.
In determining whether stock or securities are substantially
identical, you must consider all the facts and circumstances in your
particular case. Ordinarily, stocks or securities of one corporation
are not considered substantially identical to stocks or securities of
another corporation. However, they may be substantially identical in
some cases. For example, in a reorganization, the stocks and
securities of the predecessor and successor corporations may be
substantially identical.
Similarly, bonds or preferred stock of a corporation are not
ordinarily considered substantially identical to the common stock of
the same corporation. However, where the bonds or preferred stock are
convertible into common stock of the same corporation, the relative
values, price changes, and other circumstances may make these bonds or
preferred stock and the common stock substantially identical. For
example, preferred stock is substantially identical to the common
stock if the preferred stock:
- Is convertible into common stock,
- Has the same voting rights as the common stock,
- Is subject to the same dividend restrictions,
- Trades at prices that do not vary significantly from the
conversion ratio, and
- Is unrestricted as to convertibility.
More or less stock bought than sold.
If the number of shares of substantially identical stock or
securities you buy within 30 days before or after the sale is either
more or less than the number of shares you sold, you must determine
the particular shares to which the wash sale rules apply. You do this
by matching the shares bought with an equal number of the shares sold.
Match the shares bought in the same order that you bought them,
beginning with the first shares bought. The shares or securities so
matched are subject to the wash sale rules.
Example 1.
You bought 100 shares of M stock on September 24, 1999, for $5,000.
On December 21, 1999, you bought 50 shares of substantially identical
stock for $2,750. On December 28, 1999, you bought 25 shares of
substantially identical stock for $1,125. On January 4, 2000, you sold
for $4,000 the 100 shares you bought in September. You have a $1,000
loss on the sale. However, because you bought 75 shares of
substantially identical stock within 30 days of the sale, you cannot
deduct the loss ($750) on 75 shares. You can deduct the loss ($250) on
the other 25 shares. The basis of the 50 shares bought on December 21,
1999, is increased by two-thirds (50 x 75) of the $750
disallowed loss. The new basis of those shares is $3,250 ($2,750 +
$500). The basis of the 25 shares bought on December 28, 1999, is
increased by the rest of the loss to $1,375 ($1,125 + $250).
Example 2.
You bought 100 shares of M stock on September 24, 1999. On February
1, 2000, you sold those shares at a $1,000 loss. On each of the 4 days
from February 15, 2000, to February 18, 2000, you bought 50 shares of
substantially identical stock. You cannot deduct your $1,000 loss. You
must add half the disallowed loss ($500) to the basis of the 50 shares
bought on February 15. Add the other half ($500) to the basis of the
shares bought on February 16.
Loss and gain on same day.
Loss from a wash sale of one block of stock or securities cannot be
used to reduce any gains on identical blocks sold the same day.
Example.
During 1995, you bought 100 shares of X stock on each of three
occasions. You paid $158 a share for the first block of 100 shares,
$100 a share for the second block, and $95 a share for the third
block. On December 23, 2000, you sold 300 shares of X stock for $125 a
share. On January 6, 2001, you bought 250 shares of identical X stock.
You cannot deduct the loss of $33 a share on the first block because
within 30 days after the date of sale you bought 250 identical shares
of X stock. In addition, you cannot reduce the gain realized on the
sale of the second and third blocks of stock by this loss.
Dealers.
The wash sale rules do not apply to a dealer in stock or securities
if the loss is from a transaction made in the ordinary course of
business.
Short sales.
The wash sale rules apply to a loss realized on a short sale if you
sell, or enter into another short sale of, substantially identical
stock or securities within a period beginning 30 days before the date
the short sale is complete and ending 30 days after that date.
For purposes of the wash sale rules, a short sale is considered
complete on the date the short sale is entered into, if:
- On that date, you own stock or securities identical to those
sold short (or by that date you enter into a contract or option to
acquire that stock or those securities), and
- You later deliver the stock or securities to close the short
sale.
Otherwise, a short sale is not considered complete until the
property is delivered to close the sale.
Example.
On June 2, you buy 100 shares of stock for $1,000. You sell short
100 shares of the stock for $750 on October 6. On October 7, you buy
100 shares of the same stock for $750. You close the short sale on
November 17 by delivering the shares bought on June 2. You cannot
deduct the $250 loss ($1,000 - $750) because the date of
entering into the short sale (October 6) is considered the date the
sale is complete for wash sale purposes and you bought substantially
identical stock within 30 days from that date.
Residual Interests in a REMIC.
The wash sale rules generally will apply to the sale of your
residual interest in a real estate mortgage investment conduit (REMIC)
if, during the period beginning 6 months before the sale of the
interest and ending 6 months after that sale, you acquire any residual
interest in any REMIC or any interest in a taxable mortgage pool that
is comparable to a residual interest. REMICs are discussed in chapter 1.
How to report.
Report a wash sale or trade on line 1 or line 8 of Schedule D (Form
1040), whichever is appropriate. Show the full amount of the loss in
parentheses in column (f). On the next line, enter "Wash Sale" in
column (a) and the amount of the loss not allowed as a positive amount
in column (f).
Options
Options are generally subject to the rules described in this
section. If the option is part of a straddle, the loss deferral rules
covered later under Straddles may also apply. For special
rules that apply to nonequity options and dealer equity options, see
Section 1256 Contracts Marked to Market, earlier.
Gain or loss from the sale or trade of an option to buy or sell
property that is a capital asset in your hands, or would be if you
acquired it, is capital gain or loss. If the property is not, or would
not be, a capital asset, the gain or loss is ordinary gain or loss.
Example 1.
You purchased an option to buy 100 shares of XYZ Company stock. The
stock increases in value and you sell the option for more than you
paid for it. Your gain is capital gain because the stock underlying
the option would have been a capital asset in your hands.
Example 2.
The facts are the same as in Example 1, except that the stock
decreases in value and you sell the option for less than you paid for
it. Your loss is a capital loss.
Section 1231 transactions.
If you hold an option more than 1 year to buy or sell property that
is (or would be) used for business or to produce rents or royalties,
the gain or loss on its sale or trade is a section 1231 gain or loss.
For information on its treatment, see Section 1231 Gains and
Losses in chapter 3 of Publication 544.
Option not exercised.
If you do not exercise an option to buy or sell, and you have a
loss, you are considered to have sold or traded the option on the date
that it expired.
Writer of option.
If you write (grant) an option, how you report your gain or loss
depends on whether it was exercised.
If you are not in the business of writing options and an option you
write on stocks, securities, commodities, or commodity futures is not
exercised, the amount you receive is a short-term capital gain.
If an option requiring you to buy or sell property is exercised,
see Writers of calls and puts, later.
Section 1256 contract options.
Gain or loss is recognized on the exercise of an option on a
section 1256 contract. Section 1256 contracts are defined under
Section 1256 Contracts Marked to Market, earlier.
Cash settlement option.
A cash settlement option is treated as an option to buy or sell
property. A cash settlement option is any option that on exercise is
settled in, or could be settled in, cash or property other than the
underlying property.
How to report.
Gain or loss from the closing or expiration of an option that is
not a section 1256 contract, but that is a capital asset in your
hands, is reported on Schedule D (Form 1040).
If an option you purchased expired, enter the expiration date in
column (c) and write "Expired" in column (d).
If an option that you wrote expired, enter the expiration date in
column (b) and write "Expired" in column (e).
Calls and Puts
Calls and puts are options on securities and are covered by the
rules just discussed for options. The following are specific
applications of these rules to holders and writers of options that are
bought, sold, or "closed out" in transactions on a national
securities exchange, such as the Chicago Board Options Exchange. (But
see Section 1256 Contracts Marked to Market, earlier, for
special rules that may apply to nonequity options and dealer equity
options.) These rules are also presented in Table 4-1.
Calls and puts are issued by writers (grantors) to holders for cash
premiums. They are ended by exercise, closing transaction, or lapse.
A call option is the right to buy from the writer of the
option, at any time before a specified future date, a stated number of
shares of stock at a specified price. Conversely, a put option
is the right to sell to the writer, at any time before a
specified future date, a stated number of shares at a specified price.
Holders of calls and puts.
If you buy a call or a put, you may not deduct its cost. It is a
capital expenditure.
If you sell the call or the put before you exercise it, the
difference between its cost and the amount you receive for it is
either a long-term or short-term capital gain or loss, depending on
how long you held it.
If the option expires, its cost is either a long-term or short-term
capital loss, depending on your holding period, which ends on the
expiration date.
If you exercise a call, add its cost to the basis of the stock you
bought. If you exercise a put, reduce your amount realized on the sale
of the underlying stock by the cost of the put when figuring your gain
or loss. Any gain or loss on the sale of the underlying stock is long
term or short term depending on your holding period for the underlying
stock.
Put option as short sale.
Buying a put option is generally treated as a short sale, and the
exercise, sale, or expiration of the put is a closing of the short
sale. See Short Sales, earlier. If you have held the
underlying stock for 1 year or less at the time you buy the put, any
gain on the exercise, sale, or expiration of the put is a short-term
capital gain. The same is true if you buy the underlying stock after
you buy the put but before its exercise, sale, or expiration. Your
holding period for the underlying stock begins on the earliest of:
- The date you dispose of the stock,
- The date you exercise the put,
- The date you sell the put, or
- The date the put expires.
Writers of calls and puts.
If you write (grant) a call or a put, do not include the amount you
receive for writing it in your income at the time of receipt. Carry it
in a deferred account until:
- Your obligation expires,
- You sell, in the case of a call, or buy, in the case of a
put, the underlying stock when the option is exercised, or
- You engage in a closing transaction.
If your obligation expires, the amount you received for writing the
call or put is short-term capital gain.
If a call you write is exercised and you sell the underlying stock,
increase your amount realized on the sale of the stock by the amount
you received for the call when figuring your gain or loss. The gain or
loss is long term or short term depending on your holding period of
the stock.
If a put you write is exercised and you buy the underlying stock,
decrease your basis in the stock by the amount you received for the
put. Your holding period for the stock begins on the date you buy it,
not on the date you wrote the put.
If you enter into a closing transaction by paying an amount equal
to the value of the call or put at the time of the payment, the
difference between the amount you pay and the amount you receive for
the call or put is a short-term capital gain or loss.
Examples of non-dealer transactions.
- Expiration. Ten XYZ call options were issued on
April 8, 2000, for $4,000. These equity options expired in December
2000, without being exercised. If you were a holder (buyer) of the
options, you would recognize a short-term capital loss of $4,000 on
Schedule D of your 2000 return. If you were a writer of the options,
you would recognize a short-term capital gain of $4,000 on Schedule D
of your 2000 return.
- Closing transaction. The facts are the same as in
(1), except that on May 10, 2000, the options were sold for $6,000. If
you were the seller, you would recognize a short-term capital gain of
$2,000 on Schedule D of your 2000 return. If you were the writer of
the options and you bought them back, you would recognize a short-term
capital loss of $2,000 on Schedule D of your 2000 return.
- Exercise. The facts are the same as in (1),
except that the options were exercised on May 27, 2000. The buyer adds
the cost of the options to the basis of the stock bought through the
exercise of the options. The writer adds the amount received from
writing the options to the amount realized from selling the
stock.
- Section 1256 contracts. The facts
are the same as in (1),
except the options were nonequity options, subject to the rules for
section 1256 contracts. If you were a buyer of the options, you would
recognize a short-term capital loss of $1,600, and a long-term capital
loss of $2,400. If you were a writer of the options, you would
recognize a short-term capital gain of $1,600, and a long-term capital
gain of $2,400. See Section 1256 Contracts Marked to Market,
earlier, for more information.
Table 4-1 Puts and Calls
Straddles
This section discusses the loss deferral rules that apply to the
sale or other disposition of positions in a straddle. These rules do
not apply to the straddles described under Exceptions,
later.
A straddle is any set of offsetting positions on personal property.
For example, a straddle may consist of a security and a written option
to buy and a purchased option to sell on the same number of shares of
the security, with the same exercise price and period.
Personal property.
This is any property of a type that is actively traded. It includes
stock options and contracts to buy stock, but generally does not
include stock.
Straddle rules for stock.
Although stock is generally excluded from the definition of
personal property when applying the straddle rules, it is included in
the following two situations.
- The stock is part of a straddle in which at least one of the
offsetting positions is either:
- An option to buy or sell the stock or substantially
identical stock or securities, or
- A position on substantially similar or related property
(other than stock).
- The stock is in a corporation formed or availed of to take
positions in personal property that offset positions taken by any
shareholder.
Position.
A position is an interest in personal property. A position can be a
forward or futures contract or an option.
An interest in a loan that is denominated in a foreign
currency is
treated as a position in that currency. For the straddle rules,
foreign currency for which there is an active interbank market is
considered to be actively-traded personal property. See also
Foreign currency contract under Section 1256 Contracts
Marked to Market, earlier.
Offsetting position.
This is a position that substantially reduces any risk of loss you
may have from holding another position. However, if a position is part
of a straddle that is not an identified straddle (described later), do
not treat it as offsetting to a position that is part of an identified
straddle.
Presumed offsetting positions.
If you establish two or more positions, an offsetting position will
be presumed under any of the following conditions, unless otherwise
rebutted.
- The positions are established in the same personal property
(or in a contract for this property), and the value of one or more
positions varies inversely with the value of one or more of the other
positions.
- The positions are in the same personal property, even if
this property is in a substantially changed form, and the positions'
values vary inversely as described in the first condition.
- The positions are in debt instruments with a similar
maturity, and the positions' values vary inversely as described in the
first condition.
- The positions are sold or marketed as offsetting positions,
whether or not the positions are called a straddle, spread, butterfly,
or any similar name.
- The aggregate margin requirement for the positions is lower
than the sum of the margin requirements for each position if held
separately.
Related persons.
To determine if two or more positions are offsetting, you will be
treated as holding any position that your spouse holds during the same
period. If you take into account part or all of the gain or loss for a
position held by a flowthrough entity, such as a partnership or trust,
you are also considered to hold that position.
Loss Deferral Rules
Generally, you can deduct a loss on the disposition of one or more
positions only to the extent that the loss is more than any
unrecognized gain you have on offsetting positions. Unused losses are
treated as sustained in the next tax year.
Unrecognized gain.
This is:
- The amount of gain you would have had on an open position if
you had sold it on the last business day of the tax year at its fair
market value, and
- The amount of gain realized on a position if, as of the end
of the tax year, gain has been realized, but not recognized.
Example.
On July 1, 2000, you entered into a straddle. On December 16, 2000,
you closed one position of the straddle at a loss of $15,000. On
December 31, 2000, the end of your tax year, you have an unrecognized
gain of $12,750 in the offsetting open position. On your 2000 return,
your deductible loss on the position you closed is limited to $2,250
($15,000 - $12,750). You must carry forward to 2001 the unused
loss of $12,750.
Exceptions.
The loss deferral rules just described do not apply to:
- A straddle that is an identified straddle at the
end of the tax year,
- Certain straddles consisting of qualified covered call
options and the stock to be purchased under the options,
- Hedging transactions, described earlier under
Section 1256 Contracts Marked to Market, and
- Straddles consisting entirely of section 1256
contracts, as described earlier under Section 1256
Contracts Marked to Market (but see Identified straddle,
next).
Identified straddle.
An identified straddle is not subject to the loss deferral rules
just described. Instead, losses from positions in an identified
straddle are deferred until you dispose of all the positions in the
straddle.
Any straddle (other than a straddle described in (2) or (3) above)
is an identified straddle if all of the following conditions exist.
- You clearly identified the straddle on your records before
the close of the day on which you acquired it.
- All of the original positions that you identify were
acquired on the same day.
- All of the positions included in item (2) were disposed of
on the same day during the tax year, or none of the positions were
disposed of by the end of the tax year.
- The straddle is not part of a larger straddle.
Qualified covered call options and optioned stock.
A straddle is not subject to the loss deferral rules for straddles
if both of the following are true.
- All of the offsetting positions consist of one or more
qualified covered call options and the stock to be purchased from you
under the options.
- The straddle is not part of a larger straddle.
But see Special year-end rule, later, for an
exception.
A qualified covered call option is any option you grant to purchase
stock you hold (or stock you acquire in connection with granting the
option), but only if all of the following are true.
- The option is traded on a national securities exchange or
other market approved by the Secretary of the Treasury.
- The option is granted more than 30 days before its
expiration date.
- The option is not a deep-in-the-money option.
- You are not an options dealer who granted the option in
connection with your activity of dealing in options.
- Gain or loss on the option is capital gain or loss.
A deep-in-the-money option is
an option with a strike
price lower than the lowest qualified benchmark (LQB). The strike
price is the price at which the option is to be exercised. The LQB is
the highest available strike price that is less than the applicable
stock price. However, the LQB for an option with a term of more than
90 days and a strike price of more than $50 is the second highest
available strike price that is less than the applicable stock price.
Strike prices are listed in the financial section of many newspapers.
The availability of strike prices for equity options with flexible
terms does not affect the determination of the LQB for an option that
is not an equity option with flexible terms.
The applicable stock price for any stock for which an
option has been granted is:
- The closing price of the stock on the most recent day on
which that stock was traded before the date on which the option was
granted, or
- The opening price of the stock on the day on which the
option was granted, but only if that price is greater than 110% of the
price determined in (1).
If the applicable stock price is $25 or less, the LQB will be
treated as not less than 85% of the applicable stock price. If the
applicable stock price is $150 or less, the LQB will be treated as not
less than an amount that is $10 below the applicable stock price.
Example.
On May 13, 2000, you held XYZ stock and you wrote an XYZ/September
call option with a strike price of $120. The closing price of one
share of XYZ stock on May 12, 2000, was $130 1/4. The
strike prices of all XYZ/September call options offered on May 13,
2000, were as follows: $110, $115, $120, $125, $130, and $135. Because
the option has a term of more than 90 days, the LQB is $125, the
second highest strike price that is less than $130 1/4,
the applicable stock price. The call option is a deep-in-the-money
option because its strike price is lower than the LQB. Therefore, the
option is not a qualified covered call option, and the loss deferral
rules apply if you closed out the option or the stock at a loss during
the year.
Capital loss on qualified covered call options.
If you hold stock and you write a qualified covered call option on
that stock with a strike price less than the applicable stock price,
treat any loss from the option as long-term capital loss if, at the
time the loss was realized, gain on the sale or exchange of the stock
would be treated as long-term capital gain. The holding period of the
stock does not include any period during which you are the writer of
the option.
Special year-end rule.
The loss deferral rules for straddles apply if all of the following
are true.
- The qualified covered call options are closed or the stock
is disposed of at a loss during any tax year.
- Gain on disposition of the stock or gain on the options is
includible in gross income in a later tax year.
- The stock or options were held less than 30 days after the
closing of the options or the disposition of the stock.
How To Report Gains
and Losses (Form 6781)
Report each position (whether or not it is part of a straddle) on
which you have unrecognized gain at the end of the tax year and the
amount of this unrecognized gain in Part III of Form 6781.
Use Part II of Form 6781 to figure your
gains and losses on straddles before entering these amounts on
Schedule D (Form 1040). Include a copy of Form 6781 with your income
tax return.
Coordination of Loss Deferral Rules and Wash Sale Rules
Rules similar to the wash sale rules apply to any disposition of a
position or positions of a straddle. First apply Rule 1, explained
next, then apply Rule 2. However, Rule 1 applies only if stocks or
securities make up a position that is part of the straddle. If a
position in the straddle does not include stock or securities, use
Rule 2.
Rule 1.
You cannot deduct a loss on the disposition of shares of stock or
securities that make up the positions of a straddle if, within a
period beginning 30 days before the date of that disposition and
ending 30 days after that date, you acquired substantially identical
stock or securities. Instead, the loss will be carried over to the
following tax year, subject to any further application of Rule 1 in
that year. This rule will also apply if you entered into a contract or
option to acquire the stock or securities within the time period
described above. See Loss carryover, later, for more
information about how to treat the loss in the following tax year.
Dealers.
If you are a dealer in stock or securities, this loss treatment
will not apply to any losses you sustained in the ordinary course of
your business.
Example.
You are not a dealer in stock or securities. On December 2, 2000,
you bought stock in XX Corporation (XX stock) and an offsetting put
option. On December 13, 2000, there was $20 of unrealized gain in the
put option and you sold the XX stock at a $20 loss. By December 16,
2000, the value of the put option had declined, eliminating all
unrealized gain in the position. On December 16, 2000, you bought a
second XX stock position that is substantially identical to the XX
stock you sold on December 13, 2000. At the end of the year there is
no unrecognized gain in the put option or in the XX stock. Under these
circumstances, the $20 loss will be disallowed for 2000 under Rule 1
because, within a period beginning 30 days before December 13, 2000,
and ending 30 days after that date, you bought stock substantially
identical to the XX stock you sold.
Rule 2.
You cannot deduct a loss on the disposition of less than all of the
positions of a straddle (your loss position) to the extent that any
unrecognized gain at the close of the tax year in one or more of the
following positions is more than the amount of any loss disallowed
under Rule 1:
- Successor positions,
- Offsetting positions to the loss position, or
- Offsetting positions to any successor position.
Successor position.
A successor position is a position that is or was at any time
offsetting to a second position, if both of the following conditions
are met.
- The second position was offsetting to the loss position that
was sold.
- The successor position is entered into during a period
beginning 30 days before, and ending 30 days after, the sale of the
loss position.
Example 1.
On November 1, 2000, you entered into offsetting long and short
positions in non-section 1256 contracts. On November 12, 2000, you
disposed of the long position at a $10 loss. On November 14, 2000, you
entered into a new long position (successor position) that is
offsetting to the retained short position, but that is not
substantially identical to the long position disposed of on November
12, 2000. You held both positions through year end, at which time
there was $10 of unrecognized gain in the successor long position and
no unrecognized gain in the offsetting short position. Under these
circumstances, the entire $10 loss will be disallowed for 2000 because
there is $10 of unrecognized gain in the successor long position.
Example 2.
The facts are the same as in Example 1, except that at year end you
have $4 of unrecognized gain in the successor long position and $6 of
unrecognized gain in the offsetting short position. Under these
circumstances, the entire $10 loss will be disallowed for 2000 because
there is a total of $10 of unrecognized gain in the successor long
position and offsetting short position.
Example 3.
The facts are the same as in Example 1, except that at year end you
have $8 of unrecognized gain in the successor long position and $8 of
unrecognized loss in the offsetting short position. Under these
circumstances, $8 of the total $10 realized loss will be disallowed
for 2000 because there is $8 of unrecognized gain in the successor
long position.
Loss carryover.
If you have a disallowed loss that resulted from applying Rule 1
and Rule 2, you must carry it over to the next tax year and apply Rule
1 and Rule 2 to that carryover loss. For example, a loss disallowed in
1999 under Rule 1 will not be allowed in 2000, unless the
substantially identical stock or securities (which caused the loss to
be disallowed in 1999) were disposed of during 2000. In addition, the
carryover loss will not be allowed in 2000 if Rule 1 or Rule 2
disallows it.
Example.
The facts are the same as in the example under Rule 1 above, except
that on December 31, 2001, you sell the XX stock at a $20 loss and
there is $40 of unrecognized gain in the put option. Under these
circumstances, you cannot deduct in 2001 either the $20 loss
disallowed in 2000 or the $20 loss you incurred for the December 31,
2001, sale of XX stock. Rule 1 does not apply because the
substantially identical XX stock was sold during the year and no
substantially identical stock or securities were bought within the
61-day period. However, Rule 2 does apply because there is $40
of unrecognized gain in the put option, an offsetting position to the
loss positions.
Capital loss carryover.
If the sale of a loss position would have resulted in a capital
loss, you treat the carryover loss as a capital loss on the date it is
allowed, even if you would treat the gain or loss on any successor
positions as ordinary income or loss. Likewise, if the sale of a loss
position (in the case of section 1256 contracts) would have resulted
in a 60% long-term capital loss and a 40% short-term capital loss, you
treat the carryover loss under the 60/40 rule, even if you would treat
any gain or loss on any successor positions as 100% long-term or
short-term capital gain or loss.
Exceptions.
The rules for coordinating straddle losses and wash sales do not
apply to the following loss situations.
- Loss on the sale of one or more positions in a hedging
transaction. (Hedging transactions are described under Section
1256 Contracts Marked to Market, earlier.)
- Loss on the sale of a loss position in a mixed straddle
account. (See the discussion later on the mixed straddle account
election.)
- Loss on the sale of a position that is part of a straddle
consisting only of section 1256 contracts.
Holding Period and
Loss Treatment Rules
The holding period of a position in a straddle generally begins no
earlier than the date on which the straddle ends (the date you no
longer hold an offsetting position). This rule does not apply to any
position you held more than 1 year before you established the
straddle. But see Exceptions, later.
Example.
On March 6, 1999, you acquired gold. On January 4, 2000, you
entered into an offsetting short gold forward contract (nonregulated
futures contract). On April 1, 2000, you disposed of the short gold
forward contract at no gain or loss. On April 8, 2000, you sold the
gold at a gain. Because the gold had been held for 1 year or less
before the offsetting short position was entered into, the holding
period for the gold begins on April 1, 2000, the date the straddle
ended. Gain recognized on the sale of the gold will be treated as
short-term capital gain.
Loss treatment.
Treat the loss on the sale of one or more positions (the loss
position) of a straddle as a long-term capital loss if both of the
following are true.
- You held (directly or indirectly) one or more offsetting
positions to the loss position on the date you entered into the loss
position.
- You would have treated all gain or loss on one or more of
the straddle positions as long-term capital gain or loss if you had
sold these positions on the day you entered into the loss
position.
Mixed straddles.
Special rules apply to a loss position that is part of a mixed
straddle and that is a non-section 1256 position. A mixed
straddle is a straddle:
- That is not part of a larger straddle,
- In which all positions are held as capital assets,
- In which at least one (but not all) of the positions is a
section 1256 contract, and
- For which the mixed straddle election (Election A, discussed
later) has not been made.
Treat the loss as 60% long-term capital loss and 40% short-term
capital loss, if all of the following conditions apply.
- Gain or loss from the sale of one or more of the straddle
positions that are section 1256 contracts would be considered gain or
loss from the sale or exchange of a capital asset.
- The sale of no position in the straddle, other than a
section 1256 contract, would result in a long-term capital gain or
loss.
- You have not made a straddle-by-straddle identification
election (Election B) or mixed straddle account election (Election C),
both discussed later.
Example.
On March 1, 2000, you entered into a long gold forward contract. On
July 15, 2000, you entered into an offsetting short gold regulated
futures contract. You did not make an election to offset gains and
losses from positions in a mixed straddle. On August 9, 2000, you
disposed of the long forward contract at a loss. Because the gold
forward contract was part of a mixed straddle and the disposition of
this non-section 1256 position would not result in long-term capital
loss, the loss recognized on the termination of the gold forward
contract will be treated as a 60% long-term and 40% short-term capital
loss.
Exceptions.
The special holding period and loss treatment for straddle
positions does not apply to positions that:
- Constitute part of a hedging transaction,
- Are included in a straddle consisting only of section 1256
contracts, or
- Are included in a mixed straddle account (Election C),
discussed later.
Mixed Straddles
If you disposed of a position in a mixed straddle and make one of
the elections described in the following discussions, report your gain
or loss as indicated in those discussions. If you do not make any of
the elections, report your gain or loss in Part II of Form 6781. If
you disposed of the section 1256 component of the straddle, enter the
recognized loss (line 10, column (h)) or your gain (line 12, column
(f)) in Part I of Form 6781, on line 1. Do not include it on line 11
or 13 (Part II).
Mixed straddle election (Election A).
You can elect out of the marked to market rules, discussed under
Section 1256 Contracts Marked to Market, earlier, for all
section 1256 contracts that are part of a mixed straddle. Instead, the
gain and loss rules for straddles will apply to these contracts.
However, if you make this election for an option on a section 1256
contract, the gain or loss treatment discussed earlier under
Options will apply, subject to the gain and loss rules for
straddles.
You can make this election if:
- At least 1 (but not all) of the positions is a section 1256
contract, and
- Each position forming part of the straddle is clearly
identified as being part of that straddle on the day the first section
1256 contract forming part of the straddle is acquired.
If you make this election, it will apply for all later years as
well. It cannot be revoked without the consent of the IRS. If you made
this election, check box A of Form 6781. Do not report the section
1256 component in Part I.
Other elections.
You can avoid the 60% long-term capital loss treatment required for
a non-section 1256 loss position that is part of a mixed straddle,
described earlier, if you choose either of the two following elections
to offset gains and losses for these positions.
- Election B. Make a separate identification of the
positions of each mixed straddle for which you are electing this
treatment (the straddle-by-straddle identification method).
- Election C. Establish a mixed straddle account
for a class of activities for which gains and losses will be
recognized and offset on a periodic basis.
These two elections are alternatives to the mixed straddle
election. You can choose only one of the three elections. Use Form
6781 to indicate your election choice by checking box A, B, or C,
whichever applies.
Straddle-by-straddle identification election (Election B).
Under this election, you must clearly identify each position that
is part of the identified mixed straddle by the earlier of:
- The close of the day the identified mixed straddle is
established, or
- The time the position is disposed of.
If you dispose of a position in the mixed straddle before the
end of the day on which the straddle is established, this
identification must be made by the time you dispose of the position.
You are presumed to have properly identified a mixed straddle if
independent verification is used.
The basic tax treatment of gain or loss under this election depends
on which side of the straddle produced the total net gain or loss. If
the net gain or loss from the straddle is due to the section 1256
contracts, gain or loss is treated as 60% long-term capital gain or
loss and 40% short-term capital gain or loss. Enter the net gain or
loss in Part I of Form 6781 and identify the election by checking box
B.
If the net gain or loss is due to the non-section 1256 positions,
gain or loss is short-term capital gain or loss. Enter the net gain or
loss on Part I of Schedule D and identify the election.
For the specific application of the rules of this election, see
regulations section 1.1092(b)-3T.
Example.
On April 1, you entered into a non-section 1256 position and an
offsetting section 1256 contract. You also made a valid election to
treat this straddle as an identified mixed straddle. On April 8, you
disposed of the non-section 1256 position at a $600 loss and the
section 1256 contract at an $800 gain. Under these circumstances, the
$600 loss on the non-section 1256 position will be offset against the
$800 gain on the section 1256 contract. The net gain of $200 from the
straddle will be treated as 60% long-term capital gain and 40%
short-term capital gain because it is due to the section 1256
contract.
Mixed straddle account (Election C).
A mixed straddle account is an account for determining gains and
losses from all positions held as capital assets in a designated class
of activities at the time you elected to establish the account. You
must establish a separate mixed straddle account for each separate
designated class of activities.
Generally, you must determine gain or loss for each position in a
mixed straddle account as of the close of each business day of the tax
year. You offset the net section 1256 contracts against the net
non-section 1256 positions to determine the "daily account net gain
or loss."
If the daily account amount is due to non-section 1256 positions,
the amount is treated as short-term capital gain or loss. If the daily
account amount is due to section 1256 contracts, the amount is treated
as 60% long-term and 40% short-term capital gain or loss.
On the last business day of the tax year, you determine the
"annual account net gain or loss" for each account by netting the
daily account amounts for that account for the tax year. The "total
annual account net gain or loss" is determined by netting the
annual account amounts for all mixed straddle accounts that you had
established.
The net amounts keep their long-term or short-term classification.
However, no more than 50% of the total annual account net gain for the
tax year can be treated as long-term capital gain. Any remaining gain
is treated as short-term capital gain. Also, no more than 40% of the
total annual account net loss can be treated as short-term capital
loss. Any remaining loss is treated as long-term capital loss.
The election to establish one or more mixed straddle accounts for
each tax year must be made by the due date (without extensions) of
your income tax return for the immediately preceding tax year. If you
begin trading in a new class of activities during a tax year, you must
make the election for the new class of activities by the later of
either:
- The due date of your return for the immediately preceding
tax year (without extensions), or
- 60 days after you entered into the first mixed straddle in
the new class of activities.
You make the election on Form 6781 by checking box C. Attach Form
6781 to your income tax return for the immediately preceding tax year,
or file it within 60 days, if that applies. Report the annual account
net gain or loss from a mixed straddle account in Part II of Form
6781. In addition, you must attach a statement to Form 6781
specifically designating the class of activities for which a mixed
straddle account is established.
For the specific application of the rules of this election, see
regulations section 1.1092(b)-4T.
Interest expense and carrying charges relating to mixed
straddle account positions.
You cannot deduct interest and carrying charges that are allocable
to any positions held in a mixed straddle account. Treat these charges
as an adjustment to the annual account net gain or loss and allocate
them proportionately between the net short-term and the net long-term
capital gains or losses.
To find the amount of interest and carrying charges that is not
deductible and that must be added to the annual account net gain or
loss, apply the rules described in chapter 3
under Interest
expense and carrying charges on straddles to the positions held
in the mixed straddle account.
Rollover of Gain
From Publicly
Traded Securities
You may qualify for a tax-free rollover of certain gains from the
sale of publicly traded securities. This means that if you buy certain
replacement property and make the choice described in this section,
you postpone part or all of your gain.
You postpone the gain by adjusting the basis of the replacement
property as described in Basis of replacement property,
later. This postpones your gain until the year you dispose of
the replacement property.
You qualify to make this choice if you meet all the following
tests.
- You sell publicly traded securities at a gain. Publicly
traded securities are securities traded on an established securities
market.
- Your gain from the sale is a capital gain.
- During the 60-day period beginning on the date of the sale,
you buy replacement property. This replacement property must be either
common stock or a partnership interest in a
specialized small business investment
company (SSBIC). This is any partnership or corporation licensed
by the Small Business Administration under section 301(d) of the Small
Business Investment Act of 1958, as in effect on May 13, 1993.
Amount of gain recognized.
If you make the choice described in this section, you must
recognize gain only up to the following amount:
- The amount realized on the sale, minus
- The cost of any common stock or partnership interest in an
SSBIC that you bought during the 60-day period beginning on the date
of sale (and did not previously take into account on an earlier sale
of publicly traded securities).
If this amount is less than the amount of your gain, you can
postpone the rest of your gain, subject to the limit described next.
If this amount is equal to or more than the amount of your gain, you
must recognize the full amount of your gain.
Limit on gain postponed.
The amount of gain you can postpone each year is limited to the
smaller of:
- $50,000 ($25,000 if you are married and file a separate
return), or
- $500,000 ($250,000 if you are married and file a separate
return), minus the amount of gain you postponed for all earlier years.
Basis of replacement property.
You must subtract the amount of postponed gain from the basis of
your replacement property.
How to report and postpone gain.
Report the entire gain realized from the sale on line 1 or line 8
of Schedule D (Form 1040), whichever is appropriate. To make the
choice to postpone gain, enter "SSBIC Rollover" in column (a) of
the line directly below the line on which you reported the gain. Enter
the amount of gain postponed in column (f). Enter it as a loss (in
parentheses).
Your choice is revocable with the consent of the IRS.
For more information on how to postpone gain, see the Schedule D
(Form 1040) instructions.
Gains on Qualified
Small Business Stock
This section discusses two provisions of the law that may apply to
gain from the sale or trade of qualified small business stock. You may
qualify for a tax-free rollover of all or part of the gain.
You may be able to exclude part of the gain from your
income.
Qualified small business stock.
This is stock that meets all the following tests.
- It must be stock in a C corporation.
- It must have been originally issued after August 10,
1993.
- As of the date the stock was issued, the corporation must
have been a qualified small business, defined later.
- You must have acquired the stock at its original issue,
directly or through an underwriter, in exchange for money or other
property (not including stock), or as pay for services provided to the
corporation (other than services performed as an underwriter of the
stock). In certain cases, your stock may also meet this test if you
acquired it from another person who met this test, or through a
conversion or trade of qualified small business stock that you
held.
- The corporation must have met the active business
test, defined later, and must have been a C corporation during
substantially all the time you held the stock.
- Within the period beginning 2 years before and ending 2
years after the stock was issued, the corporation cannot have bought
more than a de minimis amount of its stock from you or a related
party.
- Within the period beginning 1 year before and ending 1 year
after the stock was issued, the corporation cannot have bought more
than a de minimis amount of its stock from anyone, unless the total
value of the stock it bought is 5% or less of the total value of all
its stock.
For more information about tests 6 and 7, see the regulations
under section 1202 of the Internal Revenue Code.
Qualified small business.
This is a C corporation with total gross assets of $50 million or
less at all times after August 9, 1993, and before it issued the
stock. The corporation's total gross assets immediately after it
issued the stock must also be $50 million or less.
When figuring the corporation's total gross assets, you must also
count the assets of any predecessor of the corporation. In addition,
you must treat all corporations that are members of the same
parent-subsidiary controlled group as one corporation.
Active business test.
A corporation meets this test for any period of time if, during
that period, both the following are true.
- It was an eligible corporation, defined
below.
- It used at least 80% (by value) of its assets in the active
conduct of at least one qualified trade or business,
defined below.
Exception for SSBIC.
Any specialized small business investment company (SSBIC) is
treated as meeting the active business test. An SSBIC is an eligible
corporation that is licensed to operate under section 301(d) of the
Small Business Investment Act of 1958 as in effect on May 13, 1993.
Eligible corporation.
This is any U.S. corporation other than:
- A Domestic International Sales Corporation (DISC) or a
former DISC,
- A corporation that has made, or whose subsidiary has made,
an election under section 936 of the Internal Revenue Code, concerning
the Puerto Rico and possession tax credit,
- A regulated investment company,
- A real estate investment trust (REIT),
- A real estate mortgage investment conduit (REMIC),
- A financial asset securitization investment trust (FASIT),
or
- A cooperative.
Qualified trade or business.
This is any trade or business other than:
- One involving services performed in the fields of health,
law, engineering, architecture, accounting, actuarial science,
performing arts, consulting, athletics, financial services, or
brokerage services,
- One whose principal asset is the reputation or skill of one
or more employees,
- Any banking, insurance, financing, leasing, investing, or
similar business,
- Any farming business (including the business of raising or
harvesting trees),
- Any business involving the production or extraction of
products for which percentage depletion can be claimed, or
- Any business of operating a hotel, motel, restaurant, or
similar business.
Section 1045 Rollover
You may qualify for a tax-free rollover of capital gain from the
sale of qualified small business stock held more than 6 months. This
means that, if you buy certain replacement stock and make the choice
described in this section, you postpone part or all of your gain.
You postpone the gain by adjusting the basis of the replacement
stock as described in Basis of replacement stock, below.
This postpones your gain until the year you dispose of the replacement
stock.
You can make this choice if you meet all the following tests.
- You buy replacement stock during the 60-day period beginning
on the date of the sale.
- The replacement stock is qualified small business
stock.
- The replacement stock continues to meet the active business
requirement for small business stock for at least the first 6 months
after you buy it.
Amount of gain recognized.
If you make the choice described in this section, you must
recognize the capital gain only up to the following amount:
- The amount realized on the sale, minus
- The cost of any qualified small business stock you bought
during the 60-day period beginning on the date of sale (and did not
previously take into account on an earlier sale of qualified small
business stock).
If this amount is less than the amount of your capital gain,
you can postpone the rest of that gain. If this amount equals or is
more than the amount of your capital gain, you must recognize the full
amount of your gain.
Basis of replacement stock.
You must subtract the amount of postponed gain from the basis of
your replacement stock.
Holding period of replacement stock.
Your holding period for the replacement stock includes your holding
period for the stock sold, except for the purpose of applying the
6-month holding period requirement for choosing to roll over the gain
on its sale.
How to report gain.
Report the entire gain realized from the sale on line 1 or line 8
of Schedule D (Form 1040), whichever is appropriate. To make the
choice to postpone the gain, enter "Section 1045 Rollover" in
column (a) of the line directly below the line on which you reported
the gain. Enter the amount of gain postponed in column (f). Enter it
as a loss (in parentheses).
Section 1202 Exclusion
You generally can exclude from your income one-half of your gain
from the sale or trade of qualified small business stock held by you
for more than 5 years. The taxable part of your gain equal to your
section 1202 exclusion is a 28% rate gain. See Capital Gain Tax
Rates, later.
SSBIC stock.
If the stock is specialized small business investment company
(SSBIC) stock that you bought as replacement property for publicly
traded securities you sold at a gain, you must reduce the basis of the
stock by the amount of any postponed gain on that earlier sale, as
explained earlier under Rollover of Gain From Publicly Traded
Securities. But do not reduce your basis by that amount when
figuring your section 1202 exclusion.
Limit on eligible gain.
The amount of your gain from the stock of any one issuer that is
eligible for the exclusion in 2000 is limited to the greater of:
- Ten times your basis in all qualified stock of the issuer
that you sold or exchanged during the year, or
- $10 million ($5 million for married individuals filing
separately) minus the amount of gain from the stock of the same issuer
that you used to figure your exclusion in earlier years.
How to report gain.
Report the entire gain realized from the sale in column (f) of line
8 of Schedule D (Form 1040). Report an amount equal to the excluded
gain in column (g). Directly below the line on which you report the
gain, enter "Section 1202 exclusion" in column (a) and enter the
amount of the exclusion in column (f). Enter it as a loss (in
parentheses).
More information.
For information about additional requirements that may apply, see
section 1202 of the Internal Revenue Code.
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