Capital Gains and Losses

Question 1

What rates apply to net short-term capital gains?

Answer 1

OI rates

Question 2

What is §1222?

Answer 2

the section that defines the types of capital gains and losses (short and long term)

Question 3

When do you have a “net capital gain”? What is this taxed at?

Answer 3

when there is an excess of the “net long-term capital gain for the taxable year over the net short-term capital loss for such year.” (1222(11)) capital gain rates: 15%

Question 4

How much net short-term capital loss is there, when there is a net net short-term capital gain in a given year?

Answer 4

0

Question 5

When do you have a “net short-term capital gain”? What is this taxed at?

Answer 5

when you have net short-term capital gains in excess of net long-term capital losses OI Rates

Question 6

What happens when you have an overall capital loss?

Answer 6

The capital loss can be used to offset up to 3k of OI, and then may be carried over to future years (preserving its status as LT or ST) (Ie: If net short-term capital losses exceeded net long-term capital gains, any loss carried over is a short-term capital loss; If net long-term capital losses exceeded net short-term capital gains, any loss carried over is a long-term capital loss).

Question 7

What is the procedure for going from long-term capital gain to adjusted net capital gain? What sections?

Answer 7

Long term CG (1222(3)) -> Net LTCG (1222(7)) -> Net CG (1222(11)) -> Adjusted Net CG (1(h)(3)) -> taxed @ 15% (1(h)(1)(c)) for our purposes, NCG = ANCG

Question 8

Ruth has the choice to invest in one of the following two assets: a. A $10,000 bond that will pay $1,000 interest each year for two years (which is taxed at ordinary income rates). b. $10,000 of stock that will pay no dividends and that Ruth expects to be worth $12,100 in two years when she will sell it. (Gain on sale will be taxed at the 15% capital gains rate.) If Ruth was indifferent between these investment choices, how might tax considerations influence her behavior? You should assume that she is in the 35% marginal tax bracket.

Answer 8

Would prefer B, since it’s taxed at 15%, and there are two realization events in (a) as opposed to one in (b) A isn’t CG, because there is no sale or exchange

Question 9

Dante has the following capital assets (all of which are potentially eligible for the 15% rate on “net capital gains” under § 1(h)(1)(C), depending on the outcome of the netting rules under §1222, and none of which falls under a special rate for capital gains such as under §§1250, 1231, etc.). Dante makes the following sales in the current taxable year.

Answer 9

• Labelling
  
  • Stock:
    
    • Gain = 9k
    • Long Term
  • Undeveloped Land
    
    • Gain = 2k
    • Short Term
  • Bonds
    
    • (which pay OI interest, but when you sell it, it’s CG)
    • Loss = 4k
    • Short Term
• NCG = NLTCG - NSTCL
  
  • NLTCG = 9k
  • NSTCL(1) = 4k
  • NSTCL = NSTCG - NSTCL(1) = 2k-4k = 2k
  • NCG = 7k at 15%

Question 10

What is the LT/ST cut off?

Answer 10

one year: more than a year is LT; year or less is ST

Question 11

What are capital assets?

Answer 11

personal or investment property furniture, home, stocks, bonds, car

Question 12

What is 1(h)(1)(D-E) about?

Answer 12

other preferential rates for capital gains that aren’t 15%; just need to know that they are there

Question 13

What does it have to be to count as capital gain?

Answer 13

1. meets holding period (1 year) 2. capital asset 3. sale or exchange of that asset

Question 14

What is the capital gains preference meat to mitigate? (3) What are the problems with those rationales? (2-3)

Answer 14

1. Capital-lock in: people hold on to capital assets to get their basis stepped up at death
   
   1. Doesn’t alleviate it all the way, i.e., it’s not 0%
   2. Creates a new distortion in place of old one
2. Bunching: Requires people to pay all their taxes at once, which can kick a taxpayer into a higher tax bracket
   
   1. People selling capital gains are probably already in high tax bracket
   2. You can choose when to get your realization anyway; already get the benefit of the deferral
   3. 453: Can just sell it at different times in installment
3. Inflationary: a portion of every capital gain is just inflationary
   
   1. Applies to non-capital assets
   2. You could just increase basis by inflation; “index basis for inflation”

Question 15

How does inflation work? If prices go up 100%, how much does purchasing power go down?

Answer 15

50%

Measures the rate at which the purchasing power of money increases or decreases

Question 16

Why don’t we index basis for inflation? (2)

Answer 16

1. It would be a bookkeeping nightmare (maybe)
2. Inflation is different for different assets - inflation is higher for gas (increases in price more frequently)

Question 17

What are arguments against a capital gains preference?

Answer 17

1. Efficiency: Leads to a lesser magnitude of problems in step-up stuff
2. Fairness: Richer people often have lots of capital assets and income from selling those assets
3. Administrability
   
   1. Characterization: People want to characterize their income as long-term capital gain
   2. Conversion: Want to put income into long-term capital gain

Question 18

Dante has the following capital assets (all of which are potentially eligible for the 15% rate on “net capital gains” under § 1(h)(1)(C), depending on the outcome of the netting rules under §1222, and none of which falls under a special rate for capital gains such as under §§1250, 1231, etc.). Dante makes the following sales in the current taxable year.

However, also in the current taxable year, Dante has an additional capital gain of $3000 – from the sale of a vintage automobile that he held for less than 1 year (which you should also assume is eligible for the 15% rate on “net capital gains” under § 1(h)(1)(C), depending on the outcome of the netting rules under § 1222, and which you should assume does not fall under a special rate for capital gains such as under §§ 1250, 1231, etc.). How does that change the outcome?

Answer 18

now the NCG is 9k, taxed at 15%

because NLTCG is still 9k, and now the NSTCL is 0 because:

1. there is no excess in STCL (4k) over STCG (3k+2k),
2. if there is a net short-term capital gain in a given year, then the net short-term capital loss for that year is 0
3. Labelling
   
   1. Car
      
      1. Short term
      2. Gain = 3k
      3. CG

NSTCG is still 1k, taxed at OI rates

Question 19

Dante has the following capital assets (all of which are potentially eligible for the 15% rate on “net capital gains” under § 1(h)(1)(C), depending on the outcome of the netting rules under §1222, and none of which falls under a special rate for capital gains such as under §§1250, 1231, etc.). Dante makes the following sales in the current taxable year.

However, also in the current taxable year, Dante has an additional capital gain of $3000 – from the sale of a vintage automobile that he held for less than 1 year (which you should also assume is eligible for the 15% rate on “net capital gains” under § 1(h)(1)(C), depending on the outcome of the netting rules under § 1222, and which you should assume does not fall under a special rate for capital gains such as under §§ 1250, 1231, etc.).

There is another car: it’s sold at a loss of 15k after being held for 5 years. How does that change the outcome?

Answer 19

so, now there is a LTCL = 15k

NLTCL = 6k (15k of NLTCL - 9k of NLTCG)

so, no NCG, nothing get’s taxed at 15%

NSTCG = 1k, offset up to 3k (1211(b))

NSTCL = 0

so, 5k of LTCL is preserved for later years

Question 20

Would you rather have a short term capital loss or a long term capital loss? Why?

Answer 20

Short term capital loss

short term capital gains is taxed higher, and since we net STCG against STCL in first step, STCL are more valuable (1222(5-6))

Question 21

Does anything change if Dante’s second car is the one he uses everday? Is it still a capital asset? What if this changed to the first car?

Answer 21

It’s still a capital asset, but it’s not used for T/B, production of income, or in casualty, so no longer a loss

so doesn’t get netted

if it was the second car, he sells that at a gain, and 165 is only about losses, so still have to net it

Question 22

So, what’s the summary of all this netting stuff?

Answer 22

Net capital gain is what matters, which is NLTCG - NSTCL

you get NLTCG from LTCG - LTCL (if greater than 0). If less than 0, then can use this NLTCL for 3k of OI, and in later years.

and you get NSTCL from STCL - STCG (if greater than 0). If less than 0, , then no NSTCL.

and you get NSTCG from STCG - STCL (if greater than 0), and NSTCL is 0. If less than 0, that’s the NSTCL.

Question 23

What are the two exceptions to capital assets? What section? Would you rather have OI losses or capital losses?

Answer 23

1221

1. Stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business;
2. Property, used in his trade or business, of a character which is subject to the allowance for depreciation provided in section 167, or real property used in his trade or business;

OI; 1211 doesn’t restrict the use of ordinary losses to offset ordinary income; so want to fight for these exceptions for losses

Question 24

Why is the “dealer” distinction important?

Answer 24

it’s in relation to the first exception, with regard to bonds as possible inventory items

for dealers, bonds are inventory items, and so not capital assets (but then you get OI gains along with OI losses)

for non-dealers, bonds are not inventory items, and so are capital assets (but then you get capital gains along with capital losses)