Handle your wash sales and generator your Schedule D

A capital gain is profit that generates when the price of a security held by a holder rises above its purchase price and the security is sold (realized gain). If the security continues to be held, the gain is unrealized. A short-term capital gain is the profit realized on a security held for one year or less. A long-term capital gain is the profit realized on the sale of a security held for more than one year.

How to Calculate Short- and Long-Term Capital Gains

How Capital Gains Tax is Calculated

How TradeMax Can Help Investors Calculate Capital Gains

How to Calculate Short- and Long-Term Capital Gains

The basic rule for calculating capital gains is the sales price minus the cost of selling less the adjusted tax basis (cost basis), which equals the taxable capital gain or loss.

The Taxpayer must classify the gains and losses as either ordinary or capital gains or losses, then calculate net short-term capital gains against short-term capital losses to get a total short-term capital gain or loss.
If the capital losses exceed capital gains, the amount of the excess loss that can be claimed is the lesser of $3,000, ($1,500 if you are married filing separately) or your total net loss as shown on line 16 of the Form 1040 Schedule D, Capital Gains and Losses. If your net capital loss is more than this limit, you can carry the loss forward to later years until they are used up. Use the Capital Loss Carryover Worksheet to figure the amount carried forward. But short-term and long-term capital loss which carried over previous year only deduct the short or long term capital gains in this year seperately.

How Capital Gains Tax is Calculated

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. 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. In 2003, this rate was reduced to 15%, and to 5% for individuals in the lowest two income tax brackets. The long-term capital gains are included when figuring out the investor’s tax bracket. However, the 5 or 15% rates do not apply to all long-term capital gains. Long-term capital gains on collectibles, some types of restricted stock, and certain other assets are instead subject to a minimum 28% rate. These reduced tax rates were passed with a sunset provision and are effective through 2010; if they are not extended before that time, they will expire and revert to the rates in effect before 2003, which were generally 20%.

The tax payers also should note that corporate actions such as stock split, stock merge, spin off can cause cost basis changes. That implies that the purchase price is not the cost basis. To track and monitor such actions can help investors understate capital gains leaving them liable for back taxes, interest and other penalties.

The wash sale generated during the buys and sells of a stock also contribute to the cost basis changes. A wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale you:

Buy substantially identical stock or securities,

• Acquire substantially identical stock or securities in a fully taxable trade,
• Acquire a contract or option to buy substantially identical stock or securities, or
• Acquire substantially identical stock for your individual retirement account (IRA) or Roth IRA.

A wash sale will defer losses (possibly increasing capital gains tax due) and increase the cost basis of the new tax lot.

Generally, the proceeds of any stock, bond, or other securities sold during the year will be reported on IRS Form 1099-B by the brokerage or financial institution that carried out the sale.

How TradeMax Can Help Investors Calculate Capital Gains

TradeMax provides tax lot functions to help investors calculate capital gains tax. TradeMax tracks investments and automatically adjusts for wash sales and corporate actions. TradeMax matches tax lots and calculates capital gains and losses. It also characterizes capital gains and losses as short or long-term. This information is then used to produce the Schedule D.

Stock Splits, dividends, mergers, acquisitions and spinoffs are all examples of corporate actions. For example, a company may decide to split its shares 2:1, leaving shareholders with twice as many shares as they had before. In many cases, a corporate action will result in a new position or a change to the cost basis of the security.

As a result, investors should make necessary cost basis adjustments for each security. With thousands of corporate events that affect a stock’s cost basis, the odds are good that an investor will encounter one sooner or later. some corporate actions are easy to manage, while some need more manual calculations. As every corporate action type has its own rules, the investors must learn if they want to fill their Schedule D forms accurately.

Wash sale activity can further complicate the arduous task of tracking and adjusting for corporate actions. TradeMax’s wash sale algorithms are synchronized with corporate action activity to alleviate this problem.

Cost basis, as used in United States tax law, is the original cost of property, adjusted for factors such as depreciation. When property is sold, the taxpayer pays/(saves) taxes on a capital gain/(loss) that equals the amount realized on the sale minus the sold property’s basis.

From Publication 551: “Basis is the amount of your investment in property for tax purposes. Use the basis of property to figure depreciation, amortization, depletion, and casualty losses. Also use it to figure gain or loss on the sale or other disposition of property.”

The cost basis of any investment is the original value of an asset adjusted for stock splits, dividends and capital distributions. It is used to calculate the capital gain or loss on an investment for tax purposes. The calculation of cost basis can be complicated, however, due to the many changes that will occur in the financial markets such as splits and takeovers.

For example: If the company splits its shares, this will affect your cost basis per share. Remember, however, that while a split changes an investor’s number of shares outstanding, it is a cosmetic change that affects neither the actual value of the original investment, nor the current investment. Continuing with the above example, imagine that the company issued a 2:1 stock split where one old share gets you two new shares. You can calculate you cost basis per share in two ways: First, you can take the original investment amount ($10,000) and divide it by the new amount of shares you hold (2,000 shares) to arrive at the new per share cost basis ($5 $10,000/2,000). The other way is to take your previous cost basis per share ($10) and divide it by the split factor (2:1). So in this case, you would divide $10 by 2 to get to $5.

How TradeMax Can Help with Cost Basis

TradeMax can help with cost basis calculations. Investors enter original buy and sell transactions into TradeMax. TradeMax will allow you to match sell transactions against appropriate tax lots, and adjust positions and cost basis for corporate actions and wash sales manually.

When importing trade information from some brokers, users may receive baseline positions. These are positions that investors held open at the time their brokers sent their trade data. In order for TradeMax to accurately calculate gain/loss figures, users need to input their cost basis and purchase dates for these baseline positions.

Merger is when two companies combine together to form a new company all together.  Mergers can be taxable or non-taxable. If a merger is taxable, you will need to realize an “artificial” sale and re-purchase the security. For a non-taxable merger, you will need to allocate the cost basis to the new security.

TradeMax allows to adjust each of your investments. In many cases, a corporate action, such as a merger, will result in a new position or a change to the cost basis of a security.

Qualified dividends, as defined by the United States Internal Revenue Code, are ordinary dividends that meet specific criteria to be taxed at the lower long-term capital gains tax rate rather than at higher tax rate for an individual’s ordinary income. From 2003 to 2007, qualified dividends were taxed at 15% or 5% depending on the individual’s ordinary income tax bracket, and from 2008 to 2010, the tax rate on qualified dividends was reduced to 0% for tax payers in the 10% and 15% ordinary income tax brackets.

In order to be taxed at the qualified dividend rate, the dividend must:

• be paid between January 1, 2003 and December 31, 2010,
• be paid by a U.S. corporation, by a corporation incorporated in a U.S. possession, by a foreign corporation located in a country that is eligible for benefits under a U.S. tax treaty that meets certain criteria, or on a foreign corporation’s stock that can be readily traded on an established U.S. stock market (e.g., an American Depositary Receipt or ADR), and
• the stock paying the dividend must be held for at least 61 days during the 120-day period beginning 60 days before the the ex-dividend date and ending 59 days after the ex-dividend date.

A spin-off is a corporate action that a parent company distributes 100% of its ownership interests in a subsidiary operation as a dividend to its existing shareholders. After the spin-off, there are two separate, publicly held firms that have exactly the same shareholder base. This procedure stands in contrast to an initial public offering (IPO), in which the parent company is actually selling (rather than giving away) some or all of its ownership interests in a division.

A stock split is one of  corporate actions that happens when a company changes the amounts of shares and adjusts the share’s price accordingly. A stock split  increases or decreases the number of shares in a public company. The price is adjusted such that the before and after market capitalization of the company remains the same and dilution does not occur.

For example, a company with 100 shares of stock priced at $20 per share. The market capitalization is 50 × $20, or $1000. The company splits its stock 2-for-1. There are now 100 shares of stock and each shareholder holds twice as many shares. The price of each share is adjusted to $10. The market capitalization is 100 × $10 = $1000, the same as before the split.

Stock splits are usually non-taxable. It is important to note that after a stock split, the number of shares you own in the security and the cost basis of those shares will change. Often stock splits are expressed as a fraction.  A two-for-one stock split is the most common - the investor receives one additional share for every share owned in the security.

A wash sale occurs when you sell a security at a loss but then repurchase it within 30 days at the low price.The subsequent purchase could occur before or after the security is sold, creating a 61-day window that must be monitored to identify wash sales.

IRS Explanation of Wash Sales

Wash Sale Example

How to determine Substantially Identical?

What the Wash Sale Rule Really Means to Investors

IRS Explanation of Wash Sales

wash sale occurs when you sell or otherwise dispose of stock or securities (including a contract or option to acquire or sell stock or securities) at a loss and, within 30 days before or after the sale or disposition, you:

• Buy substantially identical stock or securities,
• Acquire substantially identical stock or securities in a fully taxable trade,
• Enter into a contract or option to acquire substantially identical stock or securities, or
• Acquire substantially identical stock or securities for your individual retirement arrangement (IRA) or Roth IRA.

You cannot deduct losses from wash sales unless the loss was incurred in the ordinary course of your business as a dealer in stock or securities. The basis of the substantially identical property (or contract or option to acquire such property) is its cost increased by the disallowed loss (except in the case of (4) above). For more details on wash sales, see Pub. 550.

Report a wash sale transaction on line 1 or 8. Enter the full amount of the (loss) in column (f). Directly below the line on which you reported the loss, enter “Wash Sale” in column (a), and enter as a positive amount in column (f) the amount of the loss not allowed.

Wash Sale Example

Example 1.

You buy 100 shares of XYZ for $1,000. You sell these shares for $750 and within 30 days from the sale you buy 100 shares of the same stock for $800. Because you bought substantially identical stock, you cannot deduct your loss of $250 on the sale. However, you add the disallowed loss of $250 to the cost of the new stock, $800, to obtain your basis in the new stock, which is $1,050.

Example 2.

You are an employee of a corporation that has an incentive pay plan. Under this plan, you are given 10 shares of the corporation’s stock as a bonus award. You include the fair market value of the stock in your gross income as additional pay. You later sell these shares at a loss. If you receive another bonus award of substantially identical stock within 30 days of the sale, you cannot deduct your loss on the sale.

How to determine Subtantially Identical?

when determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case. Ordinarily, stocks or securities of one corporation are not considered substantially identical to stocks or securities of another corporation. However, they may be substantially identical in some cases. For example, in a reorganization, the stocks and securities of the predecessor and successor corporations may be substantially identical.

Similarly, bonds or preferred stock of a corporation are not ordinarily considered substantially identical to the common stock of the same corporation. However, where the bonds or preferred stock are convertible into common stock of the same corporation, the relative values, price changes, and other circumstances may make these bonds or preferred stock and the common stock substantially identical. For example, preferred stock is substantially identical to the common stock if the preferred stock:

• Is convertible into common stock,
• Has the same voting rights as the common stock,
• Is subject to the same dividend restrictions,
• Trades at prices that do not vary significantly from the conversion ratio, and
• Is unrestricted as to convertibility.

What the Wash Sale Rule Really Means to Investors

If you are an active trader in a particular stock, it is very necessary for you to track your trades and monitor your wash sales period before you re-purchase the same stock. If you suffered a loss, and you need to pay attention to the date you repurchase the substantially identical secuirty and still claim the earlier loss on taxes.

Manually tracking and figuring out the wash sale is really a time-consuming job for investors, but using a produce such as TradeMax can help manage your wash sale well, and avoid re-buying the same stock in wash-sale period.

While you will eventually realize losses deferred by wash sales, avoiding them in the first place will help you maximize your investment performance.