Foreign
income. If
you are a U.S. citizen who sells
property located outside the
United States, you must report
all gains and losses from the
sale of that property on your
tax return unless it is exempt
by U.S. law. This is true
whether you reside inside or
outside the United States and
whether or not you receive a
Form 1099 from the payer.
Introduction
This chapter discusses the
tax consequences of selling or
trading investment property. It
explains:
What a sale or trade
is,
Figuring gain or
loss,
Nontaxable trades,
Related party
transactions,
Capital gains or
losses,
Capital assets and
noncapital assets,
Holding period, and
Rollover of gain
from publicly traded
securities.
Other
property transactions.
Certain transfers of
property are not discussed
here. They are discussed in
other IRS publications.
These include:
Installment
sales, covered in
Publication 537,
Installment Sales,
Transfers of
property at death,
covered in
Publication 559,
Survivors,
Executors, and
Administrators,
Transactions
involving business
property, covered in
Publication 544,
Sales and Other
Dispositions of
Assets,
Dispositions of
an interest in a
passive activity,
covered in
Publication 925,
Passive Activity and
At-Risk Rules, and
Sales of a main
home, covered in
chapter 16.
Publication 550,
Investment Income and
Expenses (Including Capital
Gains and Losses), provides
more detailed discussion
about sales and trades of
investment property.
Publication 550 includes
information about the rules
covering nonbusiness bad
debts, straddles, section
1256 contracts, puts and
calls, commodity futures,
short sales, and wash sales.
It also discusses
investment-related expenses.
Useful Items - You
may want to see:
Publication
550
Investment Income and
Expenses
564
Mutual Fund
Distributions
Form
(and Instructions)
Schedule D (Form 1040)
Capital Gains and Losses
8824
Like-Kind Exchanges
Sales and Trades
If you sold property such as
stocks, bonds, or certain
commodities through a broker
during the year, you should
receive, for each sale, a Form
1099-B, Proceeds From Broker and
Barter Exchange Transactions, or
an equivalent statement from the
broker. You should receive the
statement by January 31 of the
next year. It will show the
gross proceeds from the sale.
The IRS will also get a copy of
Form 1099-B from the broker.
Use Form 1099-B (or an
equivalent statement received
from your broker) to complete
Schedule D (Form 1040).
What Is a
Sale or Trade?
This section explains
what is a sale or trade. It
also explains certain
transactions and events that
are treated as sales or
trades.
A sale is generally a
transfer of property for
money or a mortgage, note,
or other promise to pay
money.
A trade is a transfer of
property for other property
or services and may be taxed
in the same way as a sale.
Sale
and purchase.
Ordinarily, a
transaction is not a
trade when you
voluntarily sell
property for cash and
immediately buy similar
property to replace it.
The sale and purchase
are two separate
transactions. But see
Like-kind exchanges
under
Nontaxable Trades,
later.
Redemption of stock.
A redemption of stock
is treated as a sale or
trade and is subject to
the capital gain or loss
provisions unless the
redemption is a dividend
or other distribution on
stock.
Dividend versus sale or
trade.
Whether a redemption
is treated as a sale,
trade, dividend, or
other distribution
depends on the
circumstances in each
case. Both direct and
indirect ownership of
stock will be
considered. The
redemption is treated as
a sale or trade of stock
if:
The
redemption is
not essentially
equivalent to a
dividend (see
chapter 9),
There is a
substantially
disproportionate
redemption of
stock,
There is a
complete
redemption of
all the stock of
the corporation
owned by the
shareholder, or
The
redemption is a
distribution in
partial
liquidation of a
corporation.
Redemption or retirement
of bonds.
A redemption or
retirement of bonds or
notes at their maturity
is generally treated as
a sale or trade.
Surrender of stock.
A surrender of stock
by a dominant
shareholder who retains
control of the
corporation is treated
as a contribution to
capital rather than as
an immediate loss
deductible from taxable
income. The surrendering
shareholder must
reallocate his or her
basis in the surrendered
shares to the shares he
or she retains.
Worthless securities.Stocks, stock
rights, and bonds (other
than those held for sale
by a securities dealer)
that became worthless
during the tax year are
treated as though they
were sold on the last
day of the tax year.
This affects whether
your capital loss is
long-term or short-term.
See
Holding Period,
later.
If you are a cash
basis taxpayer and make
payments on a negotiable
promissory note that you
issued for stock that
became worthless, you
can deduct these
payments as losses in
the years you actually
make the payments. Do
not deduct them in the
year the stock became
worthless.
How
to report loss.Report worthless
securities on Schedule D
(Form 1040), line 1 or
line 8, whichever
applies. In columns (c)
and (d), enter “Worthless.”
Enter the amount of your
loss in parentheses in
column (f).
Filing a claim for
refund.
If you do not claim a
loss for a worthless
security on your
original return for the
year it becomes
worthless, you can file
a claim for a credit or
refund due to the loss.
You must use Form 1040X,
Amended U.S. Individual
Income Tax Return, to
amend your return for
the year the security
became worthless. You
must file it within 7
years from the date your
original return for that
year had to be filed, or
2 years from the date
you paid the tax,
whichever is later. For
more information about
filing a claim, see
Amended Returns and
Claims for Refund
in chapter 1.
How To
Figure Gain or
Loss
You figure gain or loss
on a sale or trade of
property by comparing the
amount you realize with the
adjusted basis of the
property.
Gain.
If the amount you
realize from a sale or
trade is more than the
adjusted basis of the
property you transfer,
the difference is a
gain.
Loss.
If the adjusted basis
of the property you
transfer is more than
the amount you realize,
the difference is a
loss.
Adjusted basis.
The adjusted basis of
property is your
original cost or other
original basis properly
adjusted (increased or
decreased) for certain
items. See chapter 14
for more information
about determining the
adjusted basis of
property.
Amount
realized.
The amount you realize
from a sale or trade of
property is everything
you receive for the
property. This includes
the money you receive
plus the fair market
value of any property or
services you receive. If
you received a note or
other debt instrument
for the property, see
How To Figure Gain
or Loss in
chapter 4 of Publication
550 to figure the amount
realized.
If you finance the
buyer's purchase of your
property and the debt
instrument does not provide
for adequate stated
interest, the unstated
interest that you must
report as ordinary income
will reduce the amount
realized from the sale. For
more information, see
Publication 537.
Fair market value.
Fair market value is
the price at which the
property would change
hands between a buyer
and a seller, neither
being forced to buy or
sell and both having
reasonable knowledge of
all the relevant facts.
Example.
You trade A Company
stock with an adjusted
basis of $7,000 for B
Company stock with a
fair market value of
$10,000, which is your
amount realized. Your
gain is $3,000 ($10,000
- $7,000).
Debt paid off.A debt against the
property, or against
you, that is paid off as
a part of the
transaction, or that is
assumed by the buyer,
must be included in the
amount realized. This is
true even if neither you
nor the buyer is
personally liable for
the debt. For example,
if you sell or trade
property that is subject
to a nonrecourse loan,
the amount you realize
generally includes the
full amount of the note
assumed by the buyer
even if the amount of
the note is more than
the fair market value of
the property.
Example.
You sell stock that
you had pledged as
security for a bank loan
of $8,000. Your basis in
the stock is $6,000. The
buyer pays off your bank
loan and pays you
$20,000 in cash. The
amount realized is
$28,000 ($20,000 +
$8,000). Your gain is
$22,000 ($28,000 -
$6,000).
Payment of cash.
If you trade property
and cash for other
property, the amount you
realize is the fair
market value of the
property you receive.
Determine your gain or
loss by subtracting the
cash you pay plus the
adjusted basis of the
property you trade in
from the amount you
realize. If the result
is a positive number, it
is a gain. If the result
is a negative number, it
is a loss.
No gain
or loss.
You may have to use a
basis for figuring gain
that is different from
the basis used for
figuring loss. In this
case, you may have
neither a gain nor a
loss. See
Basis Other Than
Cost in
chapter 14.
Nontaxable
Trades
This section discusses
trades that generally do not
result in a taxable gain or
deductible loss. For more
information on nontaxable
trades, see chapter 1 of
Publication 544.
Like-kind exchanges.
If you trade business
or investment property
for other business or
investment property of a
like kind, you do not
pay tax on any gain or
deduct any loss until
you sell or dispose of
the property you
receive. To be
nontaxable, a trade must
meet all six of the
following conditions.
The property
must be business
or investment
property. You
must hold both
the property you
trade and the
property you
receive for
productive use
in your trade or
business or for
investment.
Neither property
may be property
used for
personal
purposes, such
as your home or
family car.
The property
must not be held
primarily for
sale. The
property you
trade and the
property you
receive must not
be property you
sell to
customers, such
as merchandise.
The property
must not be
stocks, bonds,
notes, choses in
action,
certificates of
trust or
beneficial
interest, or
other securities
or evidences of
indebtedness or
interest,
including
partnership
interests.
However, you can
have a
nontaxable trade
of corporate
stocks under a
different rule,
as discussed
later.
There must
be a trade of
like property.
The trade of
real estate for
real estate, or
personal
property for
similar personal
property is a
trade of like
property. The
trade of an
apartment house
for a store
building, or a
panel truck for
a pickup truck,
is a trade of
like property.
The trade of a
piece of
machinery for a
store building
is not a trade
of like
property. Real
property located
in the United
States and real
property located
outside the
United States
are not like
property. Also,
personal
property used
predominantly
within the
United States
and personal
property used
predominantly
outside the
United States
are not like
property.
The property
to be received
must be
identified in
writing within
45 days after
the date you
transfer the
property given
up in the trade.
The property
to be received
must be received
by the earlier
of:
The
180th
day
after
the date
on which
you
transfer
the
property
given up
in the
trade,
or
The
due
date,
including
extensions,
for your
tax
return
for the
year in
which
the
transfer
of the
property
given up
occurs.
If you trade
property with a related
party in a like-kind
exchange, a special rule
may apply. See
Related Party
Transactions,
later in this chapter.
Also, see chapter 1 of
Publication 544 for more
information on exchanges
of business property and
special rules for
exchanges using
qualified intermediaries
or involving multiple
properties.
Partly
nontaxable exchange.
If you receive money
or unlike property in
addition to like
property, and the above
six conditions are met,
you have a partly
nontaxable trade. You
are taxed on any gain
you realize, but only up
to the amount of the
money and the fair
market value of the
unlike property you
receive. You cannot
deduct a loss.
Like property and unlike
property transferred.
If you give up unlike
property in addition to
the like property, you
must recognize gain or
loss on the unlike
property you give up.
The gain or loss is the
difference between the
adjusted basis of the
unlike property and its
fair market value.
Like
property and money
transferred.
If conditions (1) –
(6) are met, you have a
nontaxable trade even if
you pay money in
addition to the like
property.
Basis
of property received.
To figure the basis of
the property received,
see
Nontaxable Exchanges
in chapter 14.
How to
report.You must report the
trade of like property
on Form 8824. If you
figure a recognized gain
or loss on Form 8824,
report it on Schedule D
(Form 1040) or on Form
4797, Sales of Business
Property, whichever
applies.
For information on
using Form 4797, see
chapter 4 of Publication
544.
Corporate stocks.
The following trades
of corporate stocks
generally do not result
in a taxable gain or a
deductible loss.
Corporate
reorganizations.
In some instances, a
company will give you
common stock for
preferred stock,
preferred stock for
common stock, or stock
in one corporation for
stock in another
corporation. If this is
a result of a merger,
recapitalization,
transfer to a controlled
corporation, bankruptcy,
corporate division,
corporate acquisition,
or other corporate
reorganization, you do
not recognize gain or
loss.
Stock for stock of the
same corporation.
You can exchange
common stock for common
stock or preferred stock
for preferred stock in
the same corporation
without having a
recognized gain or loss.
This is true for a trade
between two stockholders
as well as a trade
between a stockholder
and the corporation.
Convertible stocks and
bonds.
You generally will not
have a recognized gain
or loss if you convert
bonds into stock or
preferred stock into
common stock of the same
corporation according to
a conversion privilege
in the terms of the bond
or the preferred stock
certificate.
Property for stock of a
controlled corporation.
If you transfer
property to a
corporation solely in
exchange for stock in
that corporation, and
immediately after the
trade you are in control
of the corporation, you
ordinarily will not
recognize a gain or
loss. This rule applies
both to individuals and
to groups who transfer
property to a
corporation. It does not
apply if the corporation
is an investment
company.
For this purpose, to
be in control of a
corporation, you or your
group of transferors
must own, immediately
after the exchange, at
least 80% of the total
combined voting power of
all classes of stock
entitled to vote and at
least 80% of the
outstanding shares of
each class of nonvoting
stock of the
corporation.
If this provision
applies to you, you must
attach to your return a
complete statement of
all facts pertinent to
the exchange.
Additional information.
For more information
on trades of stock, see
Nontaxable Trades
in chapter 4 of
Publication 550.
Insurance policies and
annuities.
You will not have a
recognized gain or loss
if the insured or
annuitant is the same
under both contracts and
you trade:
A life
insurance
contract for
another life
insurance
contract or for
an endowment or
annuity
contract,
An endowment
contract for an
annuity contract
or for another
endowment
contract that
provides for
regular payments
beginning at a
date not later
than the
beginning date
under the old
contract, or
An annuity
contract for
another annuity
contract.
You also may not have
to recognize gain or
loss on an exchange of a
portion of an annuity
contract for another
annuity contract. See
Revenue Ruling 2003-76
and Notice 2003-51.
Exchanges of contracts
not included in this
list, such as an annuity
contract for an
endowment contract, or
an annuity or endowment
contract for a life
insurance contract, are
taxable.
Demutualization of life
insurance companies.
If you received
stock in exchange for
your equity interest as
a policyholder or an
annuitant, you generally
will not have a
recognized gain or loss.
See
Demutualization of
Life Insurance Companies
in Publication 550.
U.S.
Treasury notes or bonds.
You can trade certain
issues of U.S. Treasury
obligations for other
issues designated by the
Secretary of the
Treasury, with no gain
or loss recognized on
the trade.
Transfers
Between Spouses
Generally, no gain or
loss is recognized on a
transfer of property from an
individual to (or in trust
for the benefit of) a
spouse, or if incident to a
divorce, a former spouse.
This nonrecognition rule
does not apply in the
following situations.
The recipient
spouse or former
spouse is a
nonresident alien.
Property is
transferred in
trust. Gain must be
recognized to the
extent the amount of
the liabilities
assumed by the
trust, plus any
liabilities on the
property, exceed the
adjusted basis of
the property.
For other situations, see
Publication 550.
Any transfer of property
to a spouse or former spouse
on which gain or loss is not
recognized is treated by the
recipient as a gift and is
not considered a sale or
exchange. The recipient's
basis in the property will
be the same as the adjusted
basis of the giver
immediately before the
transfer. This carryover
basis rule applies whether
the adjusted basis of the
transferred property is less
than, equal to, or greater
than either its fair market
value at the time of
transfer or any
consideration paid by the
recipient. This rule applies
for purposes of determining
loss as well as gain. Any
gain recognized on a
transfer in trust increases
the basis.
A transfer of property
is incident to a divorce if
the transfer occurs within 1
year after the date on which
the marriage ends, or if the
transfer is related to the
ending of the marriage.
Related
Party
Transactions
Special rules apply to
the sale or trade of
property between related
parties.
Gain on
sale or trade of
depreciable property.
Your gain from the
sale or trade of
property to a related
party may be ordinary
income, rather than
capital gain, if the
property can be
depreciated by the party
receiving it. See
chapter 3 of Publication
544 for more
information.
Like-kind exchanges.
Generally, if you
trade business or
investment property for
other business or
investment property of a
like kind, no gain or
loss is recognized. See
Like-kind exchanges
earlier under
Nontaxable Trades.
This rule also applies
to trades of property
between related parties,
defined next under
Losses on sales or
trades of property.
However, if either you
or the related party
disposes of the like
property within 2 years
after the trade, you
both must report any
gain or loss not
recognized on the
original trade on your
return filed for the
year in which the later
disposition occurs.
Losses
on sales or trades of
property. You
cannot deduct a loss on
the sale or trade of
property, other than a
distribution in complete
liquidation of a
corporation, if the
transaction is directly
or indirectly between
you and the following
related parties.
Members of
your family.
This includes
only your
brothers and
sisters,
half-brothers
and
half-sisters,
spouse,
ancestors
(parents,
grandparents,
etc.), and
lineal
descendants
(children,
grandchildren,
etc.).
A
partnership in
which you
directly or
indirectly own
more than 50% of
the capital
interest or the
profits
interest.
A
corporation in
which you
directly or
indirectly own
more than 50% in
value of the
outstanding
stock. (See
Constructive
ownership of
stock,
later.)
A tax-exempt
charitable or
educational
organization
that is directly
or indirectly
controlled, in
any manner or by
any method, by
you or by a
member of your
family, whether
or not this
control is
legally
enforceable.
In addition, a loss on
the sale or trade of
property is not
deductible if the
transaction is directly
or indirectly between
the following related
parties.
A grantor
and fiduciary,
or the fiduciary
and beneficiary,
of any trust.
Fiduciaries
of two different
trusts, or the
fiduciary and
beneficiary of
two different
trusts, if the
same person is
the grantor of
both trusts.
A trust
fiduciary and a
corporation of
which more than
50% in value of
the outstanding
stock is
directly or
indirectly owned
by or for the
trust, or by or
for the grantor
of the trust.
A
corporation and
a partnership if
the same persons
own more than
50% in value of
the outstanding
stock of the
corporation and
more than 50% of
the capital
interest, or the
profits
interest, in the
partnership.
Two S
corporations if
the same persons
own more than
50% in value of
the outstanding
stock of each
corporation.
Two
corporations,
one of which is
an S
corporation, if
the same persons
own more than
50% in value of
the outstanding
stock of each
corporation.
An executor
and a
beneficiary of
an estate
(except in the
case of a sale
or trade to
satisfy a
pecuniary
bequest).
Two
corporations
that are members
of the same
controlled
group. (Under
certain
conditions,
however, these
losses are not
disallowed but
must be
deferred.)
Two
partnerships if
the same persons
own, directly or
indirectly, more
than 50% of the
capital
interests or the
profit interests
in both
partnerships.
Multiple property sales
or trades.
If you sell or trade
to a related party a
number of blocks of
stock or pieces of
property in a lump sum,
you must figure the gain
or loss separately for
each block of stock or
piece of property. The
gain on each item may be
taxable. However, you
cannot deduct the loss
on any item. Also, you
cannot reduce gains from
the sales of any of
these items by losses on
the sales of any of the
other items.
Indirect transactions.
You cannot deduct your
loss on the sale of
stock through your
broker if, under a
prearranged plan, a
related party buys the
same stock you had
owned. This does not
apply to a trade between
related parties through
an exchange that is
purely coincidental and
is not prearranged.
Constructive ownership
of stock.
In determining whether
a person directly or
indirectly owns any of
the outstanding stock of
a corporation, the
following rules apply.
Rule 1. Stock
directly or indirectly
owned by or for a
corporation,
partnership, estate, or
trust is considered
owned proportionately by
or for its shareholders,
partners, or
beneficiaries.
Rule 2. An
individual is considered
to own the stock that is
directly or indirectly
owned by or for his or
her family. Family
includes only brothers
and sisters,
half-brothers and
half-sisters, spouse,
ancestors, and lineal
descendants.
Rule 3. An
individual owning, other
than by applying rule 2,
any stock in a
corporation is
considered to own the
stock that is directly
or indirectly owned by
or for his or her
partner.
Rule 4. When
applying rule 1, 2, or
3, stock constructively
owned by a person under
rule 1 is treated as
actually owned by that
person. But stock
constructively owned by
an individual under rule
2 or rule 3 is not
treated as owned by that
individual for again
applying either rule 2
or rule 3 to make
another person the
constructive owner of
the stock.
Property received from a
related party.If you sell or trade
at a gain property that
you acquired from a
related party, you
recognize the gain only
to the extent it is more
than the loss previously
disallowed to the
related party. This rule
applies only if you are
the original transferee
and you acquired the
property by purchase or
exchange. This rule does
not apply if the related
party's loss was
disallowed because of
the wash sale rules
described in chapter 4
of Publication 550 under
Wash sales.
If you sell or trade
at a loss property that
you acquired from a
related party, you
cannot recognize the
loss that was not
allowed to the related
party.
Example 1.
Your brother
sells you stock for
$7,600. His cost
basis is $10,000.
Your brother cannot
deduct the loss of
$2,400. Later, you
sell the same stock
to an unrelated
party for $10,500,
realizing a gain of
$2,900. Your
reportable gain is
$500 — the $2,900
gain minus the
$2,400 loss not
allowed to your
brother.
Example 2.
If, in
Example 1,
you sold the stock
for $6,900 instead
of $10,500, your
recognized loss is
only $700 (your
$7,600 basis minus
$6,900). You cannot
deduct the loss that
was not allowed to
your brother.
Capital Gains and
Losses
This section discusses the
tax treatment of gains and
losses from different types of
investment transactions.
Character
of gain or loss. You
need to classify your gains
and losses as either
ordinary or capital gains or
losses. You then need to
classify your capital gains
and losses as either short
term or long term. If you
have long-term gains and
losses, you must identify
your 28% rate gains and
losses. If you have a net
capital gain, you must also
identify any unrecaptured
section 1250 gain.
The correct classification
and identification helps you
figure the limit on capital
losses and the correct tax
on capital gains. Reporting
capital gains and losses is
explained in chapter 17.
Capital or
Ordinary Gain or
Loss
If you have a taxable
gain or a deductible loss
from a transaction, it may
be either a capital gain or
loss or an ordinary gain or
loss, depending on the
circumstances. Generally, a
sale or trade of a capital
asset (defined next) results
in a capital gain or loss. A
sale or trade of a
noncapital asset generally
results in ordinary gain or
loss. Depending on the
circumstances, a gain or
loss on a sale or trade of
property used in a trade or
business may be treated as
either capital or ordinary,
as explained in Publication
544. In some situations,
part of your gain or loss
may be a capital gain or
loss and part may be an
ordinary gain or loss.
Capital
Assets and
Noncapital
Assets
For the most part,
everything you own and use
for personal purposes,
pleasure, or investment is a
capital asset. Some examples
are:
Stocks or bonds
held in your
personal account,
A house owned
and used by you and
your family,
Household
furnishings,
A car used for
pleasure or
commuting,
Coin or stamp
collections,
Gems and
jewelry, and
Gold, silver, or
any other metal.
Any property you own is
a capital asset, except the
following noncapital assets.
Property held
mainly for sale to
customers or
property that will
physically become a
part of the
merchandise that is
for sale to
customers.
Depreciable
property used in
your trade or
business, even if
fully depreciated.
Real property
used in your trade
or business.
A copyright, a
literary, musical,
or artistic
composition, a
letter or
memorandum, or
similar property:
Created
by your
personal
efforts,
Prepared
or produced
for you (in
the case of
a letter,
memorandum,
or similar
property),
or
Acquired
under
circumstances
(for
example, by
gift)
entitling
you to the
basis of the
person who
created the
property or
for whom it
was prepared
or produced.
Accounts or
notes receivable
acquired in the
ordinary course of a
trade or business
for services
rendered or from the
sale of property
described in (1).
U.S. Government
publications that
you received from
the government for
free or for less
than the normal
sales price, or that
you acquired under
circumstances
entitling you to the
basis of someone who
received the
publications for
free or for less
than the normal
sales price.
Certain
commodities
derivative financial
instruments held by
commodities
derivatives dealers.
Hedging
transactions, but
only if the
transaction is
clearly identified
as a hedging
transaction before
the close of the day
on which it was
acquired,
originated, or
entered into.
Supplies of a
type you regularly
use or consume in
the ordinary course
of your trade or
business.
Investment
Property
Investment property
is a capital asset. Any
gain or loss from its
sale or trade is
generally a capital gain
or loss.
Gold, silver,
stamps, coins, gems,
etc.
These are capital
assets except when
they are held for
sale by a dealer.
Any gain or loss you
have from their sale
or trade generally
is a capital gain or
loss.
Stocks, stock
rights, and bonds.
All of these
(including stock
received as a
dividend) are
capital assets
except when held for
sale by a securities
dealer. However, if
you own small
business stock, see
Losses on
Section 1244 (Small
Business) Stock
and
Losses on Small
Business Investment
Company Stock
in chapter 4 of
Publication 550.
Personal use
property.
Property held for
personal use only,
rather than for
investment, is a
capital asset, and
you must report a
gain from its sale
as a capital gain.
However, you cannot
deduct a loss from
selling personal use
property.
Discounted
Debt
Instruments
Treat your gain or
loss on the sale,
redemption, or
retirement of a bond or
other debt instrument
originally issued at a
discount or bought at a
discount as capital gain
or loss, except as
explained in the
following discussions.
Short-term
government
obligations.
Treat gains on
short-term federal,
state, or local
government
obligations (other
than tax-exempt
obligations) as
ordinary income up
to your ratable
share of the
acquisition
discount. This
treatment applies to
obligations that
have a fixed
maturity date not
more than 1 year
from the date of
issue. Acquisition
discount is the
stated redemption
price at maturity
minus your basis in
the obligation.
However, do not
treat these gains as
income to the extent
you previously
included the
discount in income.
See
Discount on
Short-Term
Obligations
in chapter 1 of
Publication 550.
Short-term
nongovernment
obligations.
Treat gains on
short-term
nongovernment
obligations as
ordinary income up
to your ratable
share of original
issue discount
(OID). This
treatment applies to
obligations that
have a fixed
maturity date of not
more than 1 year
from the date of
issue.
However, to the
extent you
previously included
the discount in
income, you do not
have to include it
in income again. See
Discount on
Short-Term
Obligations
in chapter 1 of
Publication 550.
Tax-exempt state and
local government
bonds.
If these bonds
were originally
issued at a discount
before September 4,
1982, or you
acquired them before
March 2, 1984, treat
your part of the OID
as tax-exempt
interest. To figure
your gain or loss on
the sale or trade of
these bonds, reduce
the amount realized
by your part of the
OID.
If the bonds were
issued after
September 3, 1982,
and acquired after
March 1, 1984,
increase the
adjusted basis by
your part of the OID
to figure gain or
loss. For more
information on the
basis of these
bonds, see
Discounted Debt
Instruments
in chapter 4 of
Publication 550.
Any gain from
market discount is
usually taxable on
disposition or
redemption of
tax-exempt bonds. If
you bought the bonds
before May 1, 1993,
the gain from market
discount is capital
gain. If you bought
the bonds after
April 30, 1993, the
gain is ordinary
income.
You figure the
market discount by
subtracting the
price you paid for
the bond from the
sum of the original
issue price of the
bond and the amount
of accumulated OID
from the date of
issue that
represented interest
to any earlier
holders. For more
information, see
Market Discount
Bonds in
chapter 1 of
Publication 550.
A loss on the
sale or other
disposition of a
tax-exempt state or
local government
bond is deductible
as a capital loss.
Redeemed before
maturity.
If a state or
local bond that was
issued before June
9, 1980, is redeemed
before it matures,
the OID is not
taxable to you.
If a state or
local bond issued
after June 8, 1980,
is redeemed before
it matures, the part
of the OID that is
earned while you
hold the bond is not
taxable to you.
However, you must
report the unearned
part of the OID as a
capital gain.
Example.
On July 1,
1993, the date
of issue, you
bought a
20-year, 6%
municipal bond
for $800. The
face amount of
the bond was
$1,000. The $200
discount was
OID. At the time
the bond was
issued, the
issuer had no
intention of
redeeming it
before it
matured. The
bond was
callable at its
face amount
beginning 10
years after the
issue date.
The issuer
redeemed the
bond at the end
of 11 years
(July 1, 2004)
for its face
amount of $1,000
plus accrued
annual interest
of $60. The OID
earned during
the time you
held the bond,
$73, is not
taxable. The $60
accrued annual
interest also is
not taxable.
However, you
must report the
unearned part of
the OID ($127)
as a capital
gain.
Long-term debt
instruments issued
after 1954 and
before May 28, 1969
(or before July 2,
1982, if a
government
instrument).
If you sell,
trade, or redeem for
a gain one of these
debt instruments,
the part of your
gain that is not
more than your
ratable share of the
OID at the time of
the sale or
redemption is
ordinary income. The
rest of the gain is
capital gain. If,
however, there was
an intention to call
the debt instrument
before maturity, all
of your gain that is
not more than the
entire OID is
treated as ordinary
income at the time
of the sale. This
treatment of taxable
gain also applies to
corporate
instruments issued
after May 27, 1969,
under a written
commitment that was
binding on May 27,
1969, and at all
times thereafter.
Long-term debt
instruments issued
after May 27, 1969
(or after July 1,
1982, if a
government
instrument).
If you hold one of
these debt
instruments, you
must include a part
of the OID in your
gross income each
year that you own
the instrument. Your
basis in that debt
instrument is
increased by the
amount of OID that
you have included in
your gross income.
See
Original Issue
Discount (OID)
in chapter 8 for
information about
the OID that you
must report on your
tax return.
If you sell or
trade the debt
instrument before
maturity, your gain
is a capital gain.
However, if at the
time the instrument
was originally
issued there was an
intention to call it
before its maturity,
your gain generally
is ordinary income
to the extent of the
entire OID reduced
by any amounts of
OID previously
includible in your
income. In this
case, the rest of
the gain is a
capital gain.
Market discount
bonds.
If the debt
instrument has
market discount and
you chose to include
the discount in
income as it
accrued, increase
your basis in the
debt instrument by
the accrued discount
to figure capital
gain or loss on its
disposition. If you
did not choose to
include the discount
in income as it
accrued, you must
report gain as
ordinary interest
income up to the
instrument's accrued
market discount. The
rest of the gain is
capital gain. See
Market Discount
Bonds in
chapter 1 of
Publication 550.
A different rule
applies to market
discount bonds
issued before July
19, 1984, and
purchased by you
before May 1, 1993.
See
Market discount
bonds
under
Discounted Debt
Instruments
in chapter 4 of
Publication 550.
Retirement of
debt instrument.
Any amount that
you receive on the
retirement of a debt
instrument is
treated in the same
way as if you had
sold or traded that
instrument.
Notes of
individuals.
If you hold an
obligation of an
individual that was
issued with OID
after March 1, 1984,
you generally must
include the OID in
your income
currently, and your
gain or loss on its
sale or retirement
is generally capital
gain or loss. An
exception to this
treatment applies if
the obligation is a
loan between
individuals and all
of the following
requirements are
met.
The
lender is
not in the
business of
lending
money.
The
amount of
the loan,
plus the
amount of
any
outstanding
prior loans,
is $10,000
or less.
Avoiding
federal tax
is not one
of the
principal
purposes of
the loan.
If the exception
applies, or the
obligation was
issued before March
2, 1984, you do not
include the OID in
your income
currently. When you
sell or redeem the
obligation, the part
of your gain that is
not more than your
accrued share of the
OID at that time is
ordinary income. The
rest of the gain, if
any, is capital
gain. Any loss on
the sale or
redemption is
capital loss.
Deposit in
Insolvent or
Bankrupt
Financial
Institution
If you lose money you
have on deposit in a
qualified financial
institution that becomes
insolvent or bankrupt,
you may be able to
deduct your loss in one
of three ways.
Ordinary
loss,
Casualty
loss, or
Nonbusiness
bad debt
(short-term
capital loss).
Ordinary loss or
casualty loss.
If you can
reasonably estimate
your loss, you can
choose to treat the
estimated loss as
either an ordinary
loss or a casualty
loss in the current
year. Either way,
you claim the loss
as an itemized
deduction.
If you claim an
ordinary loss,
report it as a
miscellaneous
itemized deduction
on Schedule A (Form
1040), line 22. The
maximum amount you
can claim is $20,000
($10,000 if you are
married filing
separately) reduced
by any expected
state insurance
proceeds. Your loss
is subject to the
2%-of-adjusted-gross-income
limit. You cannot
choose to claim an
ordinary loss if any
part of the deposit
is federally
insured.
If you claim a
casualty loss,
attach Form 4684,
Casualties and
Thefts, to your
return. Each loss
must be reduced by
$100. Your total
casualty losses for
the year are reduced
by 10% of your
adjusted gross
income.
You cannot choose
either of these
methods if:
You own
at least 1%
of the
financial
institution,
You are
an officer
of the
institution,
or
You are
related to
such an
owner or
officer. You
are related
if you and
the owner or
officer are
“related
parties,”
as defined
earlier
under
Related
Party
Transactions,
or if you
are the
aunt, uncle,
nephew, or
niece of the
owner or
officer.
If the actual loss
that is finally
determined is more
than the amount you
deducted as an
estimated loss, you
can claim the excess
loss as a bad debt.
If the actual loss
is less than the
amount deducted as
an estimated loss,
you must include in
income (in the final
determination year)
the excess loss
claimed. See
Recoveries
in Publication 525,
Taxable and
Nontaxable Income.
Nonbusiness bad
debt.
If you choose to
treat the loss as a
bad debt, see
How to report
bad debts,
later.
Sale of
Annuity
The part of any gain
on the sale of an
annuity contract before
its maturity date that
is based on interest
accumulated on the
contract is ordinary
income.
Losses on
Section 1244
(Small
Business)
Stock
You can deduct as an
ordinary loss, rather
than as a capital loss,
your loss on the sale,
trade, or worthlessness
of section 1244 stock.
Report the loss on Form
4797, line 10.
Any gain on this
stock is capital gain
and is reported on
Schedule D (Form 1040)
if the stock is a
capital asset in your
hands. See
Losses on Section
1244 (Small Business)
Stock in
chapter 4 of Publication
550.
Losses on
Small
Business
Investment
Company
Stock
See
Losses on Small
Business Investment
Company Stock
in chapter 4 of
Publication 550.
Holding
Period
If you sold or traded
investment property, you
must determine your holding
period for the property.
Your holding period
determines whether any
capital gain or loss was a
short-term or long-term
capital gain or loss.
Long
term or short term.
If you hold investment
property more than 1
year, any capital gain
or loss is a long-term
capital gain or loss. If
you hold the property 1
year or less, any
capital gain or loss is
a short-term capital
gain or loss.
To determine how long
you held the investment
property, begin counting
on the date after the
day you acquired the
property. The day you
disposed of the property
is part of your holding
period.
Example.
If you bought
investment property
on February 5, 2003,
and sold it on
February 5, 2004,
your holding period
is not more than 1
year and you have a
short-term capital
gain or loss. If you
sold it on February
6, 2004, your
holding period is
more than 1 year and
you will have a
long-term capital
gain or loss.
Securities traded on
established market.
For securities traded
on an established
securities market, your
holding period begins
the day after the trade
date you bought the
securities, and ends on
the trade date you sold
them.
Do not confuse the
trade date with the
settlement date, which
is the date by which the
stock must be delivered
and payment must be
made.
Example.
You are a cash
method, calendar
year taxpayer. You
sold stock at a gain
on December 29,
2004. According to
the rules of the
stock exchange, the
sale was closed by
delivery of the
stock 3 trading days
after the sale, on
January 3, 2005. You
received payment of
the sales price on
that same day.
Report your gain on
your 2004 return,
even though you
received the payment
in 2005. The gain is
long term or short
term depending on
whether you held the
stock more than 1
year. Your holding
period ended on
December 29. If you
had sold the stock
at a loss, you would
also report it on
your 2004 return.
Automatic investment
service.
In determining your
holding period for
shares bought by the
bank or other agent,
full shares are
considered bought first
and any fractional
shares are considered
bought last. Your
holding period starts on
the day after the bank's
purchase date. If a
share was bought over
more than one purchase
date, your holding
period for that share is
a split holding period.
A part of the share is
considered to have been
bought on each date that
stock was bought by the
bank with the proceeds
of available funds.
Nontaxable trades.
If you acquire
investment property in a
trade for other
investment property and
your basis for the new
property is determined,
in whole or in part, by
your basis in the old
property, your holding
period for the new
property begins on the
day following the date
you acquired the old
property.
Property received as a
gift.
If you receive a gift
of property and your
basis is determined by
the donor's adjusted
basis, your holding
period is considered to
have started on the same
day the donor's holding
period started.
If your basis is
determined by the fair
market value of the
property, your holding
period starts on the day
after the date of the
gift.
Inherited property.
If you inherit
investment property,
your capital gain or
loss on any later
disposition of that
property is treated as a
long-term capital gain
or loss. This is true
regardless of how long
you actually held the
property.
Real
property bought.
To figure how long you
have held real property
bought under an
unconditional contract,
begin counting on the
day after you received
title to it or on the
day after you took
possession of it and
assumed the burdens and
privileges of ownership,
whichever happened
first. However, taking
delivery or possession
of real property under
an option agreement is
not enough to start the
holding period. The
holding period cannot
start until there is an
actual contract of sale.
The holding period of
the seller cannot end
before that time.
Stock
dividends.
The holding period for
stock you received as a
taxable stock dividend
begins on the date of
distribution.
The holding period for
new stock you received
as a nontaxable stock
dividend begins on the
same day as the holding
period of the old stock.
This rule also applies
to stock acquired in a “spin-off,”
which is a distribution
of stock or securities
in a controlled
corporation.
Nontaxable stock rights.
Your holding period
for nontaxable stock
rights begins on the
same day as the holding
period of the underlying
stock. The holding
period for stock
acquired through the
exercise of stock rights
begins on the date the
right was exercised.
Nonbusiness
Bad Debts
If someone owes you money
that you cannot collect, you
have a bad debt. You may be
able to deduct the amount
owed to you when you figure
your tax for the year the
debt becomes worthless.
Bad debts that did not
come from operating your
trade or business are
nonbusiness bad debts and
are deductible as short-term
capital losses. To be
deductible, nonbusiness bad
debts must be totally
worthless. You cannot deduct
a partly worthless
nonbusiness debt.
Genuine
debt required. A
debt must be genuine for
you to deduct a loss. A
debt is genuine if it
arises from a
debtor-creditor
relationship based on a
valid and enforceable
obligation to repay a
fixed or determinable
sum of money.
Basis
in bad debt required.To deduct a bad
debt, you must have a
basis in it — that is,
you must have already
included the amount in
your income or loaned
out your cash. For
example, you cannot
claim a bad debt
deduction for
court-ordered child
support not paid to you
by your former spouse.
If you are a cash method
taxpayer (as most
individuals are), you
generally cannot take a
bad debt deduction for
unpaid salaries, wages,
rents, fees, interest,
dividends, and similar
items.
How to
report bad debts.Deduct nonbusiness
bad debts as short-term
capital losses on
Schedule D (Form 1040).
On Schedule D, Part I,
line 1, enter the name
of the debtor and “statement
attached” in
column (a). Enter the
amount of the bad debt
in parentheses in column
(f). Use a separate line
for each bad debt.
For each bad debt,
attach a statement to
your return that
contains:
A
description of
the debt,
including the
amount, and the
date it became
due,
The name of
the debtor, and
any business or
family
relationship
between you and
the debtor,
The efforts
you made to
collect the
debt, and
Why you
decided the debt
was worthless.
For example, you
could show that
the borrower has
declared
bankruptcy, or
that legal
action to
collect would
probably not
result in
payment of any
part of the
debt.
Filing a claim for
refund.If you do not deduct
a bad debt on your
original return for the
year it becomes
worthless, you can file
a claim for a credit or
refund due to the bad
debt. To do this, use
Form 1040X to amend your
return for the year the
debt became worthless.
You must file it within
7 years from the date
your original return for
that year had to be
filed, or 2 years from
the date you paid the
tax, whichever is later.
For more information
about filing a claim,
see
Amended Returns and
Claims for Refund
in chapter 1.
Additional information.
For more information,
see
Nonbusiness Bad
Debts in
Publication 550. For
information on business
bad debts, see chapter
11 of Publication 535,
Business Expenses.
Rollover of
Gain From
Publicly Traded
Securities
You may qualify for a
tax-free rollover of certain
gains from the sale of
publicly traded securities.
This means that if you buy
certain replacement property
and make the choice
described in this section,
you postpone part or all of
your gain.
You postpone the gain by
adjusting the basis of the
replacement property as
described in
Basis of replacement
property, later.
This postpones your gain
until the year you dispose
of the replacement property.
You qualify to make this
choice if you meet all the
following tests.
You sell
publicly traded
securities at a
gain. Publicly
traded securities
are securities
traded on an
established
securities market.
Your gain from
the sale is a
capital gain.
During the
60-day period
beginning on the
date of the sale,
you buy replacement
property. This
replacement property
must be either
common stock or a
partnership interest
in a specialized
small business
investment company
(SSBIC). This is any
partnership or
corporation licensed
by the Small
Business
Administration under
section 301(d) of
the Small Business
Investment Act of
1958, as in effect
on May 13, 1993.
Amount
of gain recognized.
If you make the choice
described in this
section, you must
recognize gain only up
to the following amount.
The amount
realized on the
sale, minus
The cost of
any common stock
or partnership
interest in an
SSBIC that you
bought during
the 60-day
period beginning
on the date of
sale (and did
not previously
take into
account on an
earlier sale of
publicly traded
securities).
If this amount is less
than the amount of your
gain, you can postpone
the rest of your gain,
subject to the limit
described next. If this
amount is equal to or
more than the amount of
your gain, you must
recognize the full
amount of your gain.
Limit on gain postponed.
The amount of gain you
can postpone each year
is limited to the
smaller of:
$50,000
($25,000 if you
are married and
file a separate
return), or
$500,000
($250,000 if you
are married and
file a separate
return), minus
the amount of
gain you
postponed for
all
