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.
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.
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.
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.