12 Top Tax Questions About Capital Gains, Losses and Worthless Securities
From: www.thinkadvisor.com
This year has been one long roller-coaster ride for investors. Despite November’s stock market rally, the S&P 500 is still down about 17% year to date. Clients who leaned into the summer’s bear market may be seeing big gains, while others may be cutting their losses. And those who invested in the crypto market are literally seeing red.
All of this turmoil will come to head come tax time, and no doubt clients are already asking what their portfolio’s performance means for their tax bill. In fact, now is a great time to start discussing ways to discuss tax-loss harvesting.
Are you advising your clients correctly when it comes to capital gains and worthless securities? Check out the gallery for 12 important tax and financial planning questions and answers advisors should be aware of regarding such issues, according to ALM’s Tax Facts Online.
1. Is there a limit to the amount of capital losses a taxpayer may deduct in a tax year?
Unlike ordinary losses that are deductible against any type of income (ordinary or capital), capital losses are deductible against capital gains (both short and long term). However, a noncorporate taxpayer who has capital losses in excess of capital gains is entitled to deduct from ordinary income the lesser of (a) $3,000 ($1,500 for married taxpayers filing separately) or (b) the excess of the taxpayer’s net capital losses over gains.
Any nondeductible losses may be carried forward indefinitely to subsequent tax years. Losses that are carried forward retain their character as either short term or long term in future years.
2. When is capital gain or loss short-term?
Generally, a capital gain or loss is long term if the property giving rise to the gain or loss was owned for more than one year. It is a short-term gain or loss if the property was owned for one year or less.
To determine how long a taxpayer has owned property (i.e., his “holding period”), begin counting on the day after the property is acquired; the same date in each successive month is the first day of a new month. The date on which the property is disposed of is included (i.e., counted) in the holding period. If property is acquired on the last day of the month, the holding period begins on the first day of the following month. Therefore, if it is sold prior to the first day of the 13th month following the acquisition, the gain or loss will be short term.
3. Are there any special rules applicable in determining whether a gain or loss is long term or short term when a short sale is involved?
Whether capital gain or loss on a short sale is long term or short term will ordinarily be determined by the seller’s holding period in the stock used to close the sale. For most purposes, the capital gain or loss is long term if the holding period is more than one year. If the holding period is one year or less, the gain is short term.
In a “short sale,” a seller agrees to sell stock to another at a fixed price on a future date. If the future date is more than a year from the date the taxpayer acquired the stock, he or she would be able to convert short-term capital gain (taxed at ordinary tax rates, i.e., up to 37%) to long-term capital gain (i.e., with rates of 0%, 15% or 20%). IRC Sections 1233 and 1259 are designed to prevent such abuse.
4. What are the capital gains brackets for 2022?
For 2022, with respect to adjusted net capital gain, the 0% rate will apply to joint filers who earn less than $83,350 (half the amount for married taxpayers filing separately), heads of households who earn less than $55,800, single filers who earn less than $41,675, and trusts and estates with less than $2,800 in income.
The 15% capital gains rate will apply to joint filers who earn more than $83,350 but less than $517,200 (half the amount for married taxpayers filing separately), heads of households who earn more than $55,800 but less than $488,500, single filers who earn more than $41,675 but less than $459,750, and trusts and estates with more than $2,800 but less than $13,700 in income.
The 20% capital gains rate will apply to joint filers who earn more than $517,200 (half that amount for married taxpayers filing separately), heads of households who earn more than $488,500, single filers who earn more than $459,750, and trusts and estates with more than $13,700 in income.
5. What are the capital gains brackets for 2023?
In 2023, the 0% capital gains rate is projected to apply to joint filers who earn less than $89,250 (half of that amount for married taxpayers filing separately), heads of households who earn less than $59,750, single filers who earn less than $44,625, and trust and estates with less than $3,000 in income.
The 15% rate is projected to apply to joint filers who earn more than $89,250 but less than $553,850 (half of that amount for married taxpayers filing separately), heads of households who earn more than $59,750 but less than $523,050, single filers who earn more than $44,625, but less than $492,300 and trust and estates with more than $3,000 but less than $14,650 in income.
The 20% rate is projected to apply to joint filers who earn more than $553,850 (half of that amount for married taxpayers filing separately), heads of households who earn more than $523,050, single filers who earn more than $492,300, and trusts and estates with more than $14,650 in income.
6. How is the sale or disposition of stock or securities in a wash sale taxed?
No special tax rules apply if an investor realizes a gain in a wash sale of stock or other securities; rather, the sale will be taxed under the rules peculiar to both the type of disposition and to the particular stock or security sold.
On the other hand, to the extent that shares of stock or securities sold are replaced in a wash sale, any loss realized on the stock or securities sold may not be recognized for income tax purposes and, therefore, may not be used to offset capital gains or otherwise deducted. However, if the quantity of the stock or securities sold at a loss exceeds the quantity replaced, the loss realized on the excess shares or securities may be recognized as a capital loss for income tax purposes.
7. What rates apply to gain attributable to property classified as “collectibles”?
Gain on the sale or exchange of collectibles is taxed at 28%. “Collectibles gain” is taxable gain on the sale or exchange of a collectible that is a capital asset held for more than one year. Examples of collectibles include artwork, gems and coins.
8. How is qualified small business stock treated for tax purposes?
If certain requirements are met, a noncorporate taxpayer (including certain partnerships and S corporations) may exclude from gross income a percentage of any gain from the sale or exchange of qualified small business stock held for more than five years. The percentage limits are 50% for qualifying stock acquired prior to 2009, 75% for qualifying stock acquired in 2009 and before Sept. 28, 2010, under the American Recovery and Reinvestment Act of 2009, or 100% for qualifying stock acquired after Sept. 27, 2010.
The aggregate amount of eligible gain from the disposition of qualified small business stock issued by one corporation that may be taken into account in a tax year may not exceed the greater of (a) $10,000,000 ($5,000,000 in the case of married taxpayers filing separately) reduced by the aggregate amount of such gain taken into account in prior years, or (b) 10 times the aggregate bases of qualified stock of the issuer disposed of during the tax year. For purposes of the limitation in (b), the adjusted basis of any qualified stock will not include any additions to basis occurring after the stock was issued.
9. How is a loss realized on a sale between related persons treated for tax purposes?
If an individual sells property at a loss to a related person, that loss is disallowed and may not be used to offset capital gains for income tax purposes. It makes no difference that the sale was a bona fide, arm’s-length transaction. Neither does it matter that the sale was made indirectly through an unrelated middleman. The loss on the sale of stock will be disallowed even though the sale and purchase are made separately on a stock exchange and the stock certificates received are not the certificates sold.
If the related person to whom property was originally sold (or exchanged), sells or exchanges the same property (or property whose tax basis is determined by reference to such property) at a gain, the gain will be recognized only to the extent it exceeds the loss originally denied by reason of the related parties rules.
10. How is an investor taxed when stocks or other securities become worthless?
If an investor’s security — whether it be stock in a corporation or another security — becomes worthless at any time during the year, the loss is treated as a capital loss realized in a sale or exchange of the worthless security on the last day of that year.
Generally, the amount of the capital loss resulting from a security’s becoming worthless is the shareholder’s tax basis in the security as of the last day of the year in which it becomes worthless. Capital loss treatment will be allowed only to the extent that the loss is not compensated for by insurance or otherwise.
The loss from a capital asset that becomes worthless during a taxable year is determined as if the asset were sold or exchanged on the last day of the year; thus, the taxpayer’s holding period would apparently be determined as of that date.
11. If a taxpayer owns securities that are worthless, is a deduction permitted?
While IRC Section 166 does not apply to worthless securities, IRC Section 165 allows a deduction for losses incurred based on ownership of securities that have become completely worthless during the year. The term “security” for purposes of IRC Section 165 includes shares of stock, stock rights, or evidence of indebtedness issued by a corporation or a government.
The worthlessness of the security is a question of fact, and the loss will be disallowed unless the taxpayer is able to furnish proof of the original cost of the security. There are no fixed rules that apply when determining whether a security is completely worthless. The taxpayer is required to make a reasonable inquiry, and what is reasonable here is based on the inquiry that a reasonable person would make in order to determine the worthlessness of the securities. Worthlessness must be determined objectively.
12. Are worthless securities losses treated as ordinary loss or capital loss?
Generally, securities are classified as capital assets and any loss resulting from their disposal will receive a capital loss treatment. As a capital loss, the loss is considered to have occurred on the last day of the taxable year, which may allow the conversion of a loss that otherwise would have been treated as short-term loss into long-term loss. Despite this, IRC Section 165(g)(3) allows domestic corporate taxpayers to treat losses sustained on worthless securities as ordinary losses if an affiliated corporation issued the securities.
