Publication 544: Sales and Other Dispositions of Assets; Reporting Gains & Losses

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Table of Contents

Introduction

This chapter explains how to report capital gains and losses and ordinary gains and losses from sales, exchanges, and other dispositions of property.

Although this discussion refers to Schedule D (Form 1040), the rules discussed here also apply to taxpayers other than individuals. However, the rules for property held for personal use usually will not apply to taxpayers other than individuals.

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If you sell or exchange certain assets, you should receive an information return showing the proceeds of the sale. This information is also provided to the Internal Revenue Service.

Form 1099–B.

If you sold stocks, bonds, commodities, etc., you should receive Form 1099–B or an equivalent statement. Whether or not you receive Form 1099–B, you must report all taxable sales of stocks, bonds, commodities, etc., on Schedule D. For more information on figuring gains and losses from these transactions, see chapter 4 in Publication 550.

Form 1099–S.

An information return must be provided on certain real estate transactions. Generally, the person responsible for closing the transaction must report on Form 1099–S sales or exchanges of the following types of property.

Land (improved or unimproved), including air space.
An inherently permanent structure, including any residential, commercial, or industrial building.
A condominium unit and its related fixtures and common elements (including land).
Stock in a cooperative housing corporation.

If you sold or exchanged any of the above types of property, the reporting person must give you a copy of Form 1099–S or a statement containing the same information as the Form 1099–S.

If you receive or will receive property or services in addition to gross proceeds (cash or notes) in this transaction, the person reporting it does not have to value that property or those services. In that case, the gross proceeds reported on Form 1099–S will be less than the sales price of the property you sold. Figure any gain or loss according to the sales price, which is the total amount you realized on the transaction.

Use Schedule D to report sales, exchanges, and other dispositions of capital assets.

Before completing Schedule D (Form 1040), you may have to complete other forms as shown below.

For a sale, exchange, or involuntary conversion of business property, complete Form 4797.
For a like-kind exchange, complete Form 8824. (See Reporting the exchange under Like-Kind Exchanges in chapter 1.)
For an installment sale, complete Form 6252. (See Publication 537.)
For an involuntary conversion due to casualty or theft, complete Form 4684. (See Publication 547, Casualties, Disasters, and Thefts.)
For a disposition of an interest in, or property used in, an activity to which the at-risk rules apply, complete Form 6198, At-Risk Limitations. (See Publication 925, Passive Activity and At-Risk Rules.)
For a disposition of an interest in, or property used in, a passive activity, complete Form 8582, Passive Activity Loss Limitations. (See Publication 925.)

Personal-use property.

Report gain on the sale or exchange of property held for personal use (such as your home) on Schedule D. Loss from the sale or exchange of property held for personal use is not deductible. But if you had a loss from the sale or exchange of real estate held for personal use for which you received a Form 1099–S, report the transaction on Schedule D, even though the loss is not deductible. Complete columns (a) through (e) and enter -0- in column (f).

Where you report a capital gain or loss depends on how long you own the asset before you sell or exchange it. The time you own an asset before disposing of it is the holding period.

If you hold a capital asset 1 year or less, the gain or loss from its disposition is short term. Report it in Part I of Schedule D. If you hold a capital asset longer than 1 year, the gain or loss from its disposition is long term. Report it in Part II of Schedule D (Form 1040).

These distinctions are essential to correctly arrive at your net capital gain or loss. Capital losses are allowed in full against capital gains plus up to $3,000 of ordinary income. The tax rate for capital gains is explained later under Capital Gains Tax Rates.

Holding period.

To figure if you held property longer than 1 year, start counting on the day following the day you acquired the property. The day you disposed of the property is part of your holding period.

Example.

If you bought an asset on June 19, 2002, you should start counting on June 20, 2002. If you sold the asset on June 19, 2003, your holding period is not longer than 1 year, but if you sold it on June 20, 2003, your holding period is longer than 1 year.

Patent property.

If you dispose of patent property, you generally are considered to have held the property longer than 1 year, no matter how long you actually held it. For more information, see Patents in chapter 2.

Inherited property.

If you inherit property, you are considered to have held the property longer than 1 year, regardless of how long you actually held it.

Installment sale.

The gain from an installment sale of an asset qualifying for long-term capital gain treatment in the year of sale continues to be long term in later tax years. If it is short term in the year of sale, it continues to be short term when payments are received in later tax years.

The date the installment payment is received determines the capital gains rate that should be applied not the date the asset was sold under an installment contract.

Nontaxable exchange.

If you acquire an asset in exchange for another asset and your basis for the new asset is figured, in whole or in part, by using your basis in the old property, the holding period of the new property includes the holding period of the old property. That is, it begins on the same day as your holding period for the old property.

Example.

You bought machinery on December 4, 2002. On June 4, 2003, you traded this machinery for other machinery in a nontaxable exchange. On December 5, 2003, you sold the machinery you got in the exchange. Your holding period for this machinery began on December 5, 2002. Therefore, you held it longer than 1 year.

Corporate liquidation.

The holding period for property you receive in a liquidation generally starts on the day after you receive it if gain or loss is recognized.

Profit-sharing plan.

The holding period of common stock withdrawn from a qualified contributory profit-sharing plan begins on the day following the day the plan trustee delivered the stock to the transfer agent with instructions to reissue the stock in your name.

Gift.

If you receive a gift of property and your basis in it is figured using the donor's basis, your holding period includes the donor's holding period. For more information on basis, see Publication 551, Basis of Assets.

Real property.

To figure how long you held real property, start counting on the day after you received title to it or, if earlier, the day after you took possession of it and assumed the burdens and privileges of ownership.

However, taking 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.

Repossession.

If you sell real property but keep a security interest in it and then later repossess it, your holding period for a later sale includes the period you held the property before the original sale, as well as 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.

Nonbusiness bad debts.

Nonbusiness bad debts are short-term capital losses. For information on nonbusiness bad debts, see chapter 4 of Publication 550.

The totals for short-term capital gains and losses and the totals for long-term capital gains and losses must be figured separately.

Net short-term capital gain or loss.

Combine your short-term capital gains and losses, including your share of short-term capital gains or losses from partnerships, S corporations, and fiduciaries and any short-term capital loss carryover. Do this by adding all your short-term capital gains. Then add all your short-term capital losses. Subtract the lesser total from the other. The result is your net short-term capital gain or loss.

Net long-term capital gain or loss.

Follow the same steps to combine your long-term capital gains and losses. Include the following items.

Net section 1231 gain from Part I, Form 4797, after any adjustment for nonrecaptured section 1231 losses from prior tax years.
Capital gain distributions from regulated investment companies (mutual funds) and real estate investment trusts.
Your share of long-term capital gains or losses from partnerships, S corporations, and fiduciaries.
Any long-term capital loss carryover.

The result from combining these items with other long-term capital gains and losses is your net long-term capital gain or loss.

Net gain.

If the total of your capital gains is more than the total of your capital losses, the difference is taxable. However, the part that is not more than your net capital gain may be taxed at a rate that is lower than the rate of tax on your ordinary income. See Capital Gains Tax Rates, later.

Net loss.

If the total of your capital losses is more than the total of your capital gains, the difference is deductible. But there are limits on how much loss you can deduct and when you can deduct it. See Treatment of Capital Losses, next.

If your capital losses are more than your capital gains, you must deduct the difference even if you do not have ordinary income to offset it. The yearly limit on the amount of the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return).

Table 4–2. Holding Period for Different Types of Acquisitions

Type of acquisition:	When your holding period starts:
Stocks and bonds bought on a securities market	Day after trading date you bought security. Ends on trading date you sold security.
U.S. Treasury notes and bonds	If bought at auction, day after notification of bid acceptance. If bought through subscription, day after subscription was submitted.
Nontaxable exchanges	Day after date you acquired old property.
Gift	If your basis is giver's adjusted basis, same day as giver's holding period began. If your basis is FMV, day after date of gift.
Real property bought	Generally, day after date you received title to the property.
Real property repossessed	Day after date you originally received title to the property, but does not include time between the original sale and date of repossession.

Capital loss carryover.

Generally, you have a capital loss carryover if either of the following situations applies to you.

Your net loss on line 17 of Schedule D is more than the yearly limit.
The amount shown on line 38, Form 1040 (your taxable income without your deduction for exemptions), is less than zero.

If either of these situations applies to you for 2003, see Capital Losses under Reporting Capital Gains and Losses in chapter 4 of Publication 550 to figure the amount you can carry over to 2004.

To figure your capital loss carryover from 2003 to 2004, you will need a copy of your 2003 Form 1040 and Schedule D.

In 2004, you will treat the carryover loss as if it occurred in that year. It will be combined with any capital gains and losses you have in 2004, and any net loss will be subject to the limit for that year. Any loss not used in 2004 will be carried over to 2005.

Example.

Bob and Gloria Sampson sold property in 2003. The sale resulted in a capital loss of $7,000. The Sampsons had no other capital transactions. On their joint 2003 return, the Sampsons deduct $3,000, the yearly limit. They had taxable income of $2,000. The unused part of the loss, $4,000 ($7,000 - $3,000), is carried over to 2004.

If the Sampsons' capital loss had been $2,000, it would not have been more than the yearly limit. Their capital loss deduction would have been $2,000. They would have no carryover to 2004.

Short-term and long-term losses.

When you carry over a loss, it retains its original character as either long term or short term. A short-term loss you carry over to the next tax year is added to short-term losses occurring in that year. A long-term loss you carry over to the next tax year is added to long-term losses occurring in that year. A long-term capital loss you carry over to the next year reduces that year's long-term gains before its short-term gains.

If you have both short-term and long-term losses, your short-term losses are used first against your allowable capital loss deduction. If, after using your short-term losses, you have not reached the limit on the capital loss deduction, use your long-term losses until you reach the limit. This computation of your short-term capital loss carryover or your long-term capital loss carryover would be made on the Capital Loss Carryover Worksheet provided in the 2004 Instructions for Schedule D (Form 1040).

Joint and separate returns.

On a joint return, the capital gains and losses of a husband and wife are figured as the gains and losses of an individual. If you are married and filing a separate return, your yearly capital loss deduction is limited to $1,500. Neither you nor your spouse can deduct any part of the other's loss.

If you and your spouse once filed separate returns and are now filing a joint return, combine your separate capital loss carryovers. However, if you and your spouse once filed jointly and are now filing separately, any capital loss carryover from the joint return can be deducted only on the return of the spouse who actually had the loss.

Death of taxpayer.

Capital losses cannot be carried over after a taxpayer's death. They are deductible only on the final income tax return filed on the decedent's behalf. The yearly limit discussed earlier still applies in this situation. Even if the loss is greater than the limit, the decedent's estate cannot deduct the difference or carry it over to following years.

Corporations.

A corporation can deduct capital losses only up to the amount of its capital gains. In other words, if a corporation has a net capital loss, it cannot be deducted in the current tax year. It must be carried to other tax years and deducted from capital gains occurring in those years. For more information, see Publication 542.

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gains rates.

The term net capital gain means the amount by which your net long-term capital gain for the year is more than your net short-term capital loss.

You will need to use Part IV of Schedule D (Form 1040), and the Schedule D Tax Worksheet in certain cases, to figure your tax using the capital gains rates if both of the following are true.

For 2003, the maximum capital gains tax rates are 5%, 8%, 10%, 15%, 20%, 25%, or 28%. See Table 4–3.

If you figure your tax using the maximum capital gains rates and the regular tax computation results in a lower tax, the regular tax computation applies.

The part of a net capital gain subject to each rate is determined by first netting long-term capital gains with long-term capital losses in the following tax rate groups.

A 28% group, consisting of all the following gains and losses.
1. Collectibles gains and losses.
2. The part of the gain on qualified small business stock equal to the section 1202 exclusion.
3. Any long-term capital loss carryover.
A 25% group, consisting of unrecaptured section 1250 gain.
A 20% group, consisting of gains and losses not in the 28% or 25% group. The 20% group is lowered to 15% after May 5, 2003.

If you have a net short-term capital loss, it reduces any net gain from the 28% group, then any gain from the 25% group, and finally any net gain from the 20% (15% after May 5, 2003) group.

The resulting net gain (if any) from each group is subject to the tax rate for that group. (The 10% (5% after May 5, 2003) rate applies to a net gain from the 20% (15% after May 5, 2003) group to the extent that, if there were no capital gains rates, the net capital gain would be taxed at the 15% regular tax rate.)

Collectibles gain or loss.

This is gain or loss from the sale or exchange of a work of art, rug, antique, metal, gem, stamp, coin, or alcoholic beverage held longer than 1 year. Collectibles gain includes gain from the sale of an interest in a partnership, S corporation, or trust attributable to unrealized appreciation of collectibles.

Gain on qualified small business stock.

If you realized a gain from qualified small business stock you held longer than 5 years, you exclude up to one-half of your gain from your income. The taxable part of your gain equal to your section 1202 exclusion is a 28% rate gain. See Sales of Small Business Stock in chapter 1.

Unrecaptured section 1250 gain.

This is the part of any long-term capital gain on section 1250 property (real property) that is due to depreciation minus any net loss in the 28% group. Unrecaptured section 1250 gain cannot be more than the net section 1231 gain or include any gain otherwise treated as ordinary income. Use the worksheet in the Schedule D instructions to figure your unrecaptured section 1250 gain. For more information about section 1250 property and net section 1231 gain, see chapter 3.

The 10% capital gains rate is lowered to 8% for qualified 5-year gain before May 6, 2003. Qualified 5-year gain is long-term capital gain from the sale of property you held longer than 5 years that would otherwise be subject to the 10% or 20% capital gains rate.

After May 5, 2003, the 8% maximum capital gains tax rate for qualified 5-year gain has been eliminated for sales and other dispositions (and installment payments received after that date).

Elimination of 18% rate.

In 2006, the 20% rate was scheduled to be lowered to 18% for qualified 5-year gain from property with a holding period that began after 2000. The 18% rate and the 5-year holding period have been eliminated. The new 15% rate applies to gain on property held for more than 1 year.

Taxpayers who owned certain assets on January 1, 2001, could have elected to treat those assets as sold and repurchased on the same date, if they paid tax for 2001 on any resulting gain. The purpose of the election was to make any future gain on the asset eligible for the 18% rate. That election is irrevocable. Thus, if you made the election, you may not amend your 2001 income tax return to get a refund of the tax you paid on the resulting gain.

If you choose to include any part of a net capital gain from a disposition of investment property in investment income for figuring your investment interest deduction, you must reduce the net capital gain eligible for the capital gain tax rates by the same amount. You make this choice on Form 4952, Investment Interest Expense Deduction, line 4g. For information on making this choice, see the instructions for Form 4952. For information on the investment interest deduction, see chapter 3 in Publication 550.

Table 4-3. What Is Your Maximum Capital Gains Rate?

IF your net capital gain is from...		THEN your maximum capital gains rate is...
Collectibles gain		28%
Gain on qualified small business stock equal to the section 1202 exclusion		28%
Unrecaptured section 1250 gain		25%
Other gain, ¹ and the regular tax rate that would apply is 25% or higher		20% for sales or other dispositions before May 6, 2003
		15% for sales or other dispositions after May 5, 2003 (and installment payments received after that date)
Other gain, ¹ and the regular tax rate that would apply is lower than 25%		8%² or 10% for sales or other dispositions before May 6, 2003
		5% for sales and other dispositions after May 5, 2003 (and installment payments received after that date)
¹Other gain means any gain that is not collectibles gain, gain on qualified small business stock, or unrecaptured section 1250 gain.
²The rate is 8% only for qualified 5-year gain.

Use Form 4797 to report gain or loss from a sale, exchange, or involuntary conversion of property used in your trade or business or that is depreciable or amortizable. You can use Form 4797 with Form 1040, 1065, 1120, or 1120S.

Section 1231 gains and losses.

Show any section 1231 gains and losses in Part I. Carry a net gain to Schedule D (Form 1040) as a long-term capital gain. Carry a net loss to Part II of Form 4797 as an ordinary loss.

If you had any nonrecaptured net section 1231 losses from the preceding 5 tax years, reduce your net gain by those losses and report the amount of the reduction as an ordinary gain in Part II. Report any remaining gain on Schedule D (Form 1040). See Section 1231 Gains and Losses in chapter 3.

Ordinary gains and losses.

Show any ordinary gains and losses in Part II. This includes a net loss or a recapture of losses from prior years figured in Part I of Form 4797. It also includes ordinary gain figured in Part III.

Ordinary income from depreciation.

Figure the ordinary income from depreciation on personal property and additional depreciation on real property (as discussed in chapter 3) in Part III. Carry the ordinary income to Part II of Form 4797 as an ordinary gain. Carry any remaining gain to Part I as section 1231 gain, unless it is from a casualty or theft. Carry any remaining gain from a casualty or theft to Form 4684.

Jane Smith is single. At the beginning of 2003, she owned and operated Jane's Dress Shop at 25 Main Street, Smalltown, Virginia. On March 16, she traded the land and building where she operated her dress shop for other land and a building around the corner at 97 Oak Street. She then opened the J. Smith Hardware Store. Jane also sold all the equipment she had used in her dress shop, as well as a vacant lot across the street from the shop used for customer parking. She reports these transactions as shown in the filled-in Form 4797 and Form 8824 at the end of this chapter.

Jane sold the equipment she used in her dress shop for $3,000. She originally paid $6,000 for it on January 20, 1986, and had fully depreciated it. She realized a gain of $3,000. The gain was less than the $6,000 depreciation taken, so all her gain is ordinary income from depreciation. This amount is reported in Part III of Form 4797 and entered in Part II on line 13.

The adjusted basis of the customer parking lot (acquired in 1980) was $6,000 and its sales price was $8,000. Jane reports her $2,000 gain from the sale in Part I of Form 4797.

Jane had a nonrecaptured net section 1231 loss of $1,200. She shows this loss in Part I on line 8. The net section 1231 gain of $2,000 is more than the nonrecaptured loss, so that gain is treated as ordinary gain only up to the loss. Therefore, the loss of $1,200 on line 8 is entered as an ordinary gain in Part II of Form 4797 on line 12. The loss is also subtracted from the $2,000 gain on line 7. The $800 balance is entered on line 9.

Jane entered into a like-kind exchange by trading her business real property for other business real property, so she must report the transaction on Form 8824 and attach the form to her tax return.

On lines 16 and 17 of Form 8824, Jane enters the fair market value of her new property, $120,000, consisting of $95,000 for the building and $25,000 for the land. On line 18, she enters the adjusted basis of the old property, $100,000, consisting of $17,687 for the building and $82,313 for the land. Her realized gain on line 19 is $20,000. Under the like-kind exchange rules, this gain is not recognized. Jane enters “-0-” on line 20.

However, because there is additional depreciation of $4,405 on the old building, Jane must determine whether any of her gain has to be recognized as ordinary income under the recapture rules. The old building has an FMV of $90,000. Had the transaction been a cash sale, Jane's realized gain on the building would have been $72,313 ($90,000 – $17,687). The additional depreciation is less than that amount, so her ordinary income due to the additional depreciation would have been $4,405. That amount is less than the $95,000 fair market value of the new building, so there is no ordinary income recognized on the exchange. The $4,405 ordinary income that does not have to be reported is carried over to the new building as additional depreciation. Jane enters “-0-” on line 21 of Form 8824 and line 16 of Form 4797.

All of Jane's $20,000 gain is deferred (line 24). The basis of her new property (line 25) is $100,000, the same as the adjusted basis of her old property. Of that amount, $79,167 [($95,000 ÷ $120,000) × $100,000] is allocated to the building and $20,833 [($25,000 ÷ $120,000) × $100,000] is allocated to the land.

The entries in Part II, Form 4797, show an ordinary gain of $4,200 that is carried to line 14, Form 1040.

The entries in Part I, Form 4797, result in a long-term capital gain of $800 from section 1231 transactions. This is carried to line 11, Schedule D (Form 1040), column (f).