Gains and losses fall into two broad categories: ordinary and capital. The classification determines:
- Whether the gain/loss is recognized
- How it is taxed
- Which rate applies
Capital gains generally receive more favorable tax treatment than ordinary gains.
To analyze any transaction, determine:
- Whether the gain or loss is recognized
- The amount
- The character (ordinary vs. capital)
Investors
Investors buy and sell securities for personal investment, not as a business. They expect:
- Dividends
- Interest
- Capital appreciation
Sales of investment securities produce capital gains or losses, reported on:
- Form 8949
- Schedule D
Investors are subject to:
- Capital loss limits
- Wash sale rules
Commissions increase basis or reduce proceeds; they are not deductible. Investment income is not subject to self‑employment tax.
Securities Traders
A trader in securities is engaged in a business if:
- They seek profit from daily market movements
- Activity is substantial
- Activity is carried on with continuity and regularity
Factors include:
- Holding periods
- Frequency and size of trades
- Time devoted
- Whether trading is a livelihood
A taxpayer may be both a trader (for some securities) and an investor (for others). Investment securities must be separately identified.
Traders may:
- Deduct business expenses on Schedule C
- Avoid investment interest limits
- Still treat commissions as basis adjustments
- Avoid self‑employment tax on trading gains
If no mark‑to‑market election, gains/losses remain capital.
Mark‑to‑Market Election (Section 475)
A trader may elect mark‑to‑market, which:
- Treats year‑end FMV changes as ordinary income or loss
- Eliminates capital loss limits
- Eliminates wash sale rules
- Requires reporting on Form 4797
Election must be made by the due date of the prior year’s return. Late elections are generally not allowed.
Holding Period
Holding period determines whether a gain/loss is:
- Short‑term (1 year or less) → taxed as ordinary income
- Long‑term (more than 1 year) → eligible for capital gain rates
Begins day after acquisition and includes the day of sale.
Gain Recognition Concepts
- Amount realized = everything received (cash, FMV property, services, liabilities assumed)
- Realized gain/loss = amount realized − adjusted basis
- Recognized gain/loss = amount included in taxable income
Some transactions defer recognition (e.g., like‑kind exchanges, installment sales).
Capital Assets
Most personal and investment property is a capital asset.
Use the acronym I SAID for what is not a capital asset:
- Intangibles created by the taxpayer
- Supplies
- Accounts/notes receivable
- Inventory
- Depreciable business property and real estate
Personal‑use property is a capital asset, but losses are not deductible.
Investment Property
Investment property (stocks, bonds, metals, collectibles) is a capital asset unless held by a dealer. Depreciation recapture applies when selling depreciable investment property.
Digital Asset Transactions
Digital assets are treated as property, not currency.
Digital assets include:
- Cryptocurrencies
- Stablecoins
- NFTs
A taxpayer must answer the digital asset question on Form 1040.
A digital asset transaction occurs if the taxpayer:
- Receives digital assets (payment, reward, mining, staking, airdrop)
- Sells, exchanges, or disposes of digital assets
- Pays fees using digital assets
Not a transaction:
- Holding assets without transacting
- Buying with real currency
- Transfers between wallets owned by the taxpayer (unless paying fees in digital assets)
Tax Treatment
- Capital gain/loss → Form 8949 + Schedule D
- Ordinary income (mining, staking, business payments) → Schedule 1 or Schedule C
- Wages paid in digital assets → Form 1040 wages
Recordkeeping is required for all digital asset activity.
Capital Gains and Losses
A capital gain occurs when:
A capital loss occurs when:
Netting Rules
- Net short‑term gains and losses
- Net long‑term gains and losses
- Combine the two results
The character of the final net amount follows the larger component.
Maximum Capital Gain Rates
|
Type of Gain |
Max Rate |
|
Collectibles, §1202 stock |
28% |
|
Unrecaptured §1250 gain |
25% |
|
All other long‑term gains |
20% |
Short‑term gains are taxed at ordinary rates.
2025 thresholds determine whether gains fall into the 0%, 15%, or 20% brackets.
Net Capital Loss Rules
Individuals may deduct up to:
- $3,000 per year (single, HOH, MFJ)
- $1,500 (MFS)
Excess losses carry forward indefinitely, retaining character.
Capital losses cannot be carried back.
Losses of a decedent expire on the final return.
Capital Loss Carryover
Short‑term losses are used first. Long‑term losses apply next.
Carryovers retain their original character.
Schedule D and Form 8949
Form 8949 reports each individual capital transaction. Schedule D summarizes:
- Totals from Form 8949
- Gains/losses from other forms
- Capital loss carryovers
Schedule D is not required if the only capital gains are distributions reported directly on Form 1040.
Section 1244 Small Business Stock
Losses on Section 1244 stock may be deducted as ordinary losses up to:
- $50,000 per year (single)
- $100,000 (MFJ)
Corporation must meet the $1,000,000 capitalization limit.