Gains and Losses

You figure gain or loss on the disposition of your shares by comparing the amount you realize with the adjusted basis of your shares. If the amount you realize is more than the adjusted basis of the shares, you have a gain. If the amount you realize is less than the adjusted basis of the shares, you have a loss.

Amount you realize.   The amount you realize from a disposition of your shares is the money and value of any property you receive for the shares disposed of, minus your expenses of sale (such as redemption fees, sales commissions, sales charges, or exit fees).

Adjusted basis.   Adjusted basis is explained under Keeping Track of Your Basis, earlier. Also see the explanations of cost basis and average basis under Identifying the Shares Sold, earlier.

Wash sales.   If you sell mutual fund shares at a loss and within 30 days before or after the sale you buy, acquire in a taxable exchange, or acquire a contract or option to buy substantially identical shares, you have a wash sale. You cannot deduct losses from wash sales.

Substantially identical.   In determining whether the shares are substantially identical, you must consider all the facts and circumstances. Ordinarily, shares issued by one mutual fund are not considered to be substantially identical to shares issued by another mutual fund.

For more information on wash sales, get Publication 550.

Reporting information from Form 1099-B.   Mutual funds and brokers report dispositions of mutual fund shares on Form 1099-B, or a substitute form containing substantially the same language. The form shows the amount of the sales price and indicates whether the amount reported is the gross amount or the net amount (gross amount minus commissions).

If your Form 1099-B or similar statement from the payer shows the gross sales price, do not subtract the expenses of sale from it when reporting your sales price in column (d) on Schedule D. Instead, report the gross amount in column (d) and increase your cost or other basis, column (e), by any expense of the sale. If your Form 1099-B shows that the gross sales price less commissions was reported to IRS, enter the net amount in column (d) of Schedule D and do not increase your basis in column (e) by the sales commission.

Example 1.   You sold 100 shares of Fund HIJ for $2,500. You paid a $75 commission to the broker for handling the sale. Your Form 1099-B shows that the net sales proceeds, $2,425 ($2,500 - $75), were reported to the IRS. Report $2,425 in column (d) of Schedule D.

Example 2.   You sold 200 shares of Fund KLM for $10,000. You paid a $100 commission at the time of the sale. You bought the shares for $5,000. The broker reported the gross proceeds to IRS on Form 1099-B, so you enter $10,000 in column (d) of Schedule D and increase your basis in column (e) to $5,100.

Note.   Whether you use Schedule D's line 1 (for a short-term gain or loss) or line 8 (for a long-term gain or loss) depends on how long you held the shares, discussed next.

Holding Period

When you dispose of your mutual fund shares, you must determine your holding period. Your holding period determines whether the gain or loss is a short-term capital gain or loss or a long-term capital gain or loss.

Short-term gain or loss.   If you hold the shares for one year or less, your gain or loss will be a short-term gain or loss.

Long-term gain or loss.   If you hold the shares for more than one year, your gain or loss will be a long-term gain or loss.

Determining period held.   Determine your holding period by using the trade dates of your purchases and your sales. The trade date is the date on which you contract to buy or sell shares. Most mutual funds will show the trade dates on confirmation statements showing your purchases and sales.

Do not confuse the trade date with the settlement date, which is the date by which the mutual fund shares must be delivered and payment must be made.

To find out how long you have held your shares, begin counting on the day after the trade date on which you bought the shares. (Do not count the trade date itself.) The trade date on which you dispose of the shares is counted as part of your holding period.

Example.   If you bought shares on January 11, 2001 (trade date), and sold them on January 11, 2002 (trade date), your holding period would not be more than one year. If you sold them on January 12, 2002, your holding period would be more than one year (12 months plus 1 day).

Mutual fund shares received as a gift.   If you receive a gift of mutual fund shares and your basis is determined by the donor's basis, your holding period is considered to have started on the same day that the donor's holding period started.

Inherited mutual fund shares.   If you inherit mutual fund shares, you are considered to have held the shares for more than one year, regardless of how long you actually held them. Report the sale of inherited mutual fund shares on line 8 of Schedule D and enter INHERITED in column (b) instead of the date you acquired the shares.

Reinvested distributions.   If your dividends and capital gain distributions are reinvested in new shares, the holding period of each new share begins the day after that share was purchased. Therefore, if you sell both the new shares and the original shares, you might have both short-term and long-term gains and losses.

Certain short-term losses.   Special rules may apply if you have a short-term loss on the sale of shares on which you received an exempt-interest dividend or a capital gain distribution.

Exempt-interest dividends before short-term loss.   If you received exempt-interest dividends on mutual fund shares that you held for 6 months or less and sold at a loss, you may claim only the part of the loss that is more than the exempt-interest dividends. On Schedule D, column (d), increase the sales price by the amount of exempt-interest dividends. Report the loss as a short-term capital loss.

Example.   On January 8, 2002, you bought a mutual fund share for $40. On February 4, 2002, the mutual fund paid a $5 dividend from tax-exempt interest, which is not taxable to you. On February 12, 2002, you sold the share for $34. If it were not for the tax-exempt dividend, your loss would be $6 ($40 - $34). However, you must increase the sales price from $34 to $39 (to account for the $5 portion of the loss that is not deductible). You can deduct only $1 as a short-term capital loss.

Capital gain distribution before short-term loss.   Generally, if you received capital gain distributions (or had to report undistributed capital gains) on mutual fund shares that you held for 6 months or less and sold at a loss, report only the part of the loss that is more than the capital gain distribution (or undistributed capital gain) as a short-term capital loss. The rest of the loss is reported as a long-term capital loss.

Example.   On April 8, 2002, you bought a mutual fund share for $20. On June 25, 2002, the mutual fund paid a capital gain distribution of $2 a share, which is taxed as a long-term capital gain. On July 11, 2002, you sold the share for $17.50. If it were not for the capital gain distribution, your loss would be a short-term loss of $2.50 ($20-$17.50). However, the part of the loss that is not more than the capital gain distribution ($2) must be reported as a long-term capital loss. The remaining $0.50 of the loss can be reported as a short-term capital loss.

How To Figure Net Gain or Loss

Separate your short-term gains and losses from your long-term gains and losses on all the mutual fund shares and other capital assets you disposed of during the year. Then determine your net short-term gain or loss and your net long-term gain or loss.

Net short-term capital gain or loss.   Net short-term capital gain or loss is determined by adding the gains and losses from lines 1 through 6 in column (f) of Part I, Schedule D (Form 1040), Capital Gains and Losses. Line 7 is the net short-term capital gain or loss.

Net long-term capital gain or loss.   Net long-term capital gain or loss is determined by adding the gains and losses from lines 8 through 14 in column (f) of Part II, Schedule D (Form 1040). Line 16 is the net long-term capital gain or loss.

In figuring the net long-term capital gain or loss, you should include any undistributed capital gain you reported on line 11 of Schedule D and any capital gain distributions you reported on line 13 of Schedule D.

Total net gain or loss.   The total net gain or loss is determined by combining the net short-term capital gain or loss on line 7 with the net long-term capital gain or loss on line 16. Enter the result on line 17 of Part III, Schedule D (Form 1040). If line 17 shows a gain, enter the amount on line 13 of Form 1040. If line 17 shows a loss, see Limit on Capital Loss Deduction, later.

Figuring Your Tax

If you are reporting capital gain distributions on Form 1040A, use the Capital Gain Tax Worksheet in the Form 1040A instructions to figure your tax. See How To Report, earlier, to see whether you can report your capital gain distributions on Form 1040A.

If you are reporting capital gain distributions on Form 1040, but are not required to file Schedule D, use the Capital Gain Tax Worksheet in the Form 1040 instructions to figure your tax. See How To Report, earlier, to see whether you must file Schedule D.

If you are required to file Schedule D, you will need to use Part IV of Schedule D (Form 1040) to figure your tax if both of the following are true.

1. You have a net capital gain. You have a net capital gain if both lines 16 and 17 of Schedule D are gains.
2. Your taxable income on Form 1040, line 41, is more than zero.

If you have any collectibles gain, gain on qualified small business stock, or unrecaptured section 1250 gain, you may also have to use the Schedule D Tax Worksheet in the Schedule D instructions to figure your tax. See the directions below line 19 of Schedule D.

Capital Gain Tax Rates

The tax rates that apply to a net capital gain are generally lower than the tax rates that apply to other income. These lower rates are called the maximum capital gain rates.

The term net capital gain means the amount by which your net long-term capital gain for the year is more than any net short-term capital loss.

The maximum capital gain rate can be 8%, 10%, 20%, 25%, or 28%. See Table 4.

The maximum capital gain rate does not apply if it is higher than your regular tax rate.

Table 4. What Is Your Maximum Capital Gain Rate?

IF your net capital gain is from. . .	THEN your maximum capital gain rate is. . .
collectibles gain	28%
gain on qualified small business stock equal to the section 1202 exclusion	28%
unrecaptured section 1250 gain	25%
other gain 1 and the regular tax rate that would apply is 27% or higher	20%
other gain 1 and the regular tax rate that would apply is lower than 27%	8% 2 or 10%

1 Other gain means any gain that is not collectibles gain, gain on qualified small business stock, or unrecaptured section 1250 gain.

2 The rate is 8% only for qualified 5-year gain.

Example.   You have a capital gain distribution that is a section 1202 gain, so the maximum capital gain rate on the distribution would be 28%. Because you are single and your taxable income is $25,000, none of your taxable income will be taxed above the 15% rate. The 28% rate does not apply.

8% rate.   The 10% maximum capital gain rate is lowered to 8% for qualified 5-year gain.

Qualified 5-year gain.   Qualified 5-year gain is capital gain from the sale of property that was held for more than 5 years.

Note.   Your mutual fund may issue Form 1099-DIV or Form 2439 showing qualified 5-year gain. Enter these amounts and any other qualified 5-year gain on the Qualified 5-Year Gain Worksheet, in the instructions for Schedule D (Form 1040).

18% capital gain rate.   Beginning in 2006, the 20% maximum capital gain rate will be lowered to 18% for qualified 5-year gain. The holding period for the property sold must have begun after 2000.

Limit on Capital Loss Deduction

If line 17 of Part III, Schedule D (Form 1040) shows a loss, your allowable capital loss deduction is the smaller of:

1. $3,000 ($1,500 if you are married and filing a separate return), or
2. Your total net loss shown on line 17 of Schedule D.

Enter your allowable loss on line 13 of Form 1040.

Example.   Bob and Gloria sold all of their shares in a mutual fund. The sale resulted in a capital loss of $7,000. They had no other sales of capital assets during the year. On their joint return, they can deduct $3,000, which is the smaller of their loss or the net capital loss limit.

If Bob and Gloria's capital loss had been $2,000, their capital loss deduction would have been $2,000, because it is less than the $3,000 limit.

Capital loss carryover.   If your total net loss is more than your allowable capital loss deduction, you may carry over the excess to later years until it is completely used up. To determine your capital loss carryover, subtract from your total net loss the lesser of:

1. Your allowable capital loss deduction for the year, or
2. Your taxable income increased by your allowable capital loss deduction for the year and by your deduction for personal exemptions.

If your deductions exceed your gross income, you start the computation in (2) above with a negative number.

Use the Capital Loss Carryover Worksheet in the Schedule D instructions to figure your capital loss carryover.

When carried over, the loss will keep its original character as long-term or short-term. Therefore, a long-term capital loss carried over from a previous year will offset long-term gains of the current year before it offsets short-term gains of the current year. For more information on figuring capital loss carryovers, get Publication 550.

Separate returns.   Capital loss carryovers from separate returns are combined if you now file a joint return. However, if you once filed jointly and are now filing separately, a capital loss carryover from the joint return can be deducted only on the separate return of the spouse who actually had the loss.

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