Monday, November 21, 2011

Capital Gains - Law School

From Wikipedia:  A capital gains tax is a tax charged on capital gains, the profit realized on the sale of a non-inventory asset that was purchased at a lower price. The most common capital gains are realized from the sale of stocks, bonds, precious metals and property.

A capital gain is a profit that results from investments into a capital asset, such as stocks, bonds or real estate, which exceeds the purchase price. It is the difference between a higher selling price and a lower purchase price, resulting in a financial gain for the investor.  Conversely, a capital loss arises if the proceeds from the sale of a capital asset are less than the purchase price.

NOTES:
-Code requires a taxable event that causes the taxpayer to realize a gain or loss (taxation is limited to realized gains).
--No definition of "realized".
--No realization occurs when property merely appreciates in value; the property must be sold or otherwise disposed of for a taxable event to occur.
---Capital gain or Ordinary gain?
-Taxpayers generally prefer capital gains because they are taxed at lower rates, but prefer ordinary losses, which are deductible in full from ordinary income.  Capital losses generally are deductible only to the extent of capital gains plus (for individuals) a limited amount of ordinary income.

From Wikipedia:  In the United States, individuals and corporations pay income tax on the net total of all their capital gains just as they do on other sorts of income. Capital gains are generally taxed at a preferential rate in comparison to ordinary income. This is intended to provide incentives for investors to make capital investments, to fund entrepreneurial activity, and to compensate for the effect of inflation and the corporate income tax. The amount an investor is taxed depends on both his or her tax bracket, and the amount of time the investment was held before being sold. Short-term capital gains are taxed at the investor's ordinary income tax rate, and are defined as investments held for a year or less before being sold. Long-term capital gains, which apply to assets held for more than one year, are taxed at a lower rate than short-term gains.

Noncorporate Taxpayers
-Holding period is 12 months.
--Taxpayer must have held property for more than 12 months before any gain from its sale qualifies as a long-term capital gain subject to the lowest rates (currently 15% or 5% if the gain otherwise would be taxed at 10 or 15 percent).
Process
1.  must separate short-term gains against short-term losses.
--Short-term gains > Short-term losses = net short term gain.
--Short term gains < short-term losses = net short term loss.
2.  Do same for long-term gains/lossses.
3. Short-term gain or loss is netted against long term gain/loss.
--If: short-term capital gain > net long term capital-loss = excess (net capital gain) taxed at preferential capital gains rate.
--When the taxpayer has both a net short-term gain and a net long-term gain, the former is taxed in full as ordinary income, and latter is subject to favorable rate. 
-Do losses exceed gains? 
--Excess capital loss offsets up to $3000 ordinary income each taxable year.
--Any excess not allowed in one taxable year is carried forward indefinitely until it is completely realized.


Examples:

Taxable income = $100,000 (excluding capital gains/losses)
Long term capital gain = $5000
Long term capital loss = ($1000)
-Net Long term capital gain = $4000 ($5000-1000)
Short term capital gain = $2000
Short term capital loss = ($3,500)
-Net Short term capital loss ($1,500) ($2000-3500)
Net Capital Gain = $2,500 ($4000-1500)

Taxable income of $100k (excluding capital gains) is taxed at the ordinary income rates.  Net capital gain of $2,500 is taxed at a 15% rate.
---
Taxable income = $100,000 (excluding capital gains/losses)

Long term capital gain = $5000
Long term capital loss = ($1000)
-Net Long term capital gain = $4000 ($5000-1000)
Short term capital gain = $2000
Short term capital loss = ($500)
-Net Short term capital gain $1,500 ($2000-500)

Taxable income of $100k plus the net short-term capital gain of $1500 is taxed at the ordinary income rates.  The net long-term capital gain of $4000 is taxed at a 15% rate.
---
Example: net capital loss of $2,500
-Taxpayer is permitted to net the capital loss up to $3,000 of ordinary income.  If the taxpayer has a taxable income of $100,000 for the taxable year excluding capital gains and losses, the taxpayer would have $97,500 taxable income taxed at ordinary income rates.

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