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Special Edition: Gains, Losses, and Taxes: Tax Treatments for Home and Stock Sales
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Gains, Losses, and Taxes:
Tax Treatments for Home and Stock Sales Recession or no recession? That may be the philosophical question of the week for economists, but tax preparers have to deal with matters that are decidedly less abstract. Given the crisis in the home finance sector of the economy, and the current seepage of those troubles into the broader area of securities, we thought a refresher in the complicated tax treatment of homes sales and securities disposition might be in order. Here are some issues Taxsoftware.com thought you just may need to know this tax season, when the slump, downtown, recession, or whatever it is may have taxpayers selling more assets than usual. The following Q&A, excerpted from IRS publications, should clear up any questions that arise regarding property or securities and the taxes they entail.
Residence and Investment Property Q: I sold my principal residence this year. What form do I need to file? A: For home sales after May 6, 1997, if you meet the ownership and use tests, you will generally only need to report the sale of your home if your gain exceeds a certain dollar amount prescribed by law. To determine the amount of gain that can be excluded from income refer to Publication 523, Selling Your Home. You may be entitled to exclude gain from income if during the 5-year period ending on the date of the sale, you have: * Owned the home for at least 2 years (the ownership test), * Lived in the home as your main home for at least 2 years (the use test), and * During the 2-year period ending on the date of sale, you did not exclude gain from the sale of another home. If you owned and lived in the property as your main home for less than 2 years, you may still be able to claim a reduced exclusion in some cases. If you are required or choose to report a gain, it is reported on Form 1040, Schedule D, Capital Gains and Losses. If you were on qualified extended duty in the U.S. Armed Services or the intelligence community (sales or exchanges after December 20, 2006, and before 2011) you may suspend the five-year test period for up to 10 years. You may use this provision for only one property at a time. You are on qualified extended duty when the extended duty lasts for more than 90 days or for an indefinite period AND: * At a duty station that is at least 50 miles from the residence sold, or
*
When residing under orders in government housing. Q: If I sell my home and use the money I receive to pay off the mortgage, do I have to pay taxes on that money? A: The amount of gain on the sale over your cost, or basis, determines whether you will have to include any proceeds as taxable income on your return. You may be able to exclude this gain from income up to a maximum dollar limit. If you can exclude all of the gain, you do not need to report the sale on your tax return. To determine the maximum dollar limit you can exclude or for additional information on selling your home, refer to Publication 523, Selling Your Home. Q: If I take the exclusion of capital gain tax on the sale of my old home this year, can I also take the exclusion again if I sell my new home in the future? A: With the exception of the 2-year waiting period, there is no limit on the number of times you can exclude the gain on the sale of your principal residence so long as you meet the ownership and use tests. Q: Is the loss on the sale of your home deductible? A: The loss on the sale of a personal residence is a nondeductible personal loss. Q: I lived in a home as my principal residence for the first 2 of the last 5 years. For the last 3 years, the home was a rental property before selling it. Can I still avoid the capital gains tax and, if so, how should I deal with the depreciation I took while it was rented out? A: If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years and lived in it as your main home for at least 2 years, you can exclude up to the maximum dollar limit. However, you cannot exclude the portion of the gain equal to depreciation allowed or allowable for periods after May 6, 1997. This gain is reported on Form 4797, Sale of Business Property. If you can show by adequate records or other evidence that the depreciation allowed was less that the amount allowable, the amount you cannot exclude is the amount allowed. Refer to Publication 523, Selling Your Home, and Form 4797, Sale of Business Property, for specifics on calculating and reporting the amount of gain. Q: How do you report the sale of a second residence? A: Your second home is considered a capital asset. Use Form 1040, Schedule D to report sales, exchanges, and other dispositions of capital assets. Q: I have investment property. Can you explain the term basis of assets? A: Basis is your investment in property for tax purposes. The difference between the selling price of your assets and your basis determines whether there is a taxable gain or loss on the disposition of your property. You need to determine your basis to figure allowable depreciation deductions as well. Your original basis is usually your cost to acquire the asset. Your adjusted basis (which is the basis you use to determine gain or loss or depreciation amounts) is the result of increasing or decreasing your original basis according to certain events. Increases to basis include but are not limited to: . The cost of improvements having a useful life of more than a year . Assessments for local improvements . Sales tax that is not deducted . The cost of extending utilities lines to your property . Legal fees such as the cost of defending or perfecting title . Zoning costs Decreases to basis include but are not limited to: . Depreciation amortization and depletion deductions . Nontaxable corporate distributions . Insurance reimbursements for casualty and theft losses . Easements . Rebates from the manufacturer or seller Q: What is the basis of property received as a gift? A: To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you. You also must know its fair market value (FMV) at the time it was given to you and whether any gift tax was paid.
If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property. If the FMV is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift. See Gifts received before 1977 in Publication 551, Basis of Assets. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property. IRS Publications: Publication 523, Selling Your Home Tax Topic 701, Sale of your Home - after May 6, 1997 Tax Topic 703, Basis of Assets Publication 527, Residential Rental Property Publication 544, Sales and Other Dispositions of Assets Publication 551, Basis of Assets Publication 587, Business Use of Your Home Tax Topic 409, Capital Gains and Losses Publication 950, Introduction to Estate and Gift Taxes
Stocks: Gains, Losses, Dividends, and Employer Purchase Plans Q: How do I figure the cost basis of stock that has split, giving me more of the same stock, so I can figure my capital gain (or loss) on the sale of the stock?
Q: How do I figure the cost basis when the stocks I'm selling were purchased at various times and at different prices? A: If you can identify which shares of stock you sold, your basis is what you paid for the shares sold (plus sales commissions). If you sell a block of the same kind of stock, you can report all the shares sold at the same time as one sale, writing VARIOUS in the "date acquired" column of Form 1040, Schedule D. However, what you enter into the "cost or other basis" column is the total of all the acquisition costs of the shares sold. If you cannot adequately identify the shares you sold and you bought the shares at various times for different prices, the basis of the stock sold is the basis of the shares you acquired first (first-in first-out). Except for certain mutual fund shares, you cannot use the average price per share to figure gain or loss on the sale of stock. Q: How do we show on our tax return where dividends are reinvested? A: Some corporations allow investors to choose to use their dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan, you must report the fair market value on the dividend payment date of the dividends that are reinvested as income on your tax return. You do not actually show that the dividends were reinvested on your return. Keep records of the dollar amount of the reinvested dividends, the number of additional shares purchased, and the purchase dates. You will need this information to establish your basis when you sell the shares. Report the dividends that were reinvested with your other dividends, if any, on Form 1040 or Form 1040A. If your total income from ordinary dividends exceeds a dollar amount set by law, you also must file either Form 1040, Schedule B or Form 1040A, Schedule 1. Q: How do I compute the basis for stock I sold, when I received the stock over several years through a dividend reinvestment plan? A: The basis of the stock you sold is the cost of the shares plus any adjustments, such as sales commissions. If you have not kept detailed records of your dividend reinvestments, you may be able to reconstruct those records with the help of public records from sources such as the media, your broker, or the company that issued the dividends. If you cannot specifically identify which shares were sold, you must use the first-in first-out rule. This means that you deem that you sold the oldest shares first, then the next oldest, until you have accounted for the number of shares in the sale. In order to establish the basis of these shares, you need to have kept adequate documentation of all your purchases, including those that were made through the dividend reinvestment plan. You may not use an average cost basis. Only mutual fund shares may have an average cost basis. Q: How do I report participation in an employee stock purchase plan on my tax return?
A:
If you participated in an employee stock purchase plan, you do not
include any amount in your gross income as a result of the grant or
exercise of your option to purchase stock. When you sell the stock that
you purchased by exercising the option, you may have to report
compensation and capital gain or capital loss.
Q: I purchased stock from my employer under an employee stock purchase plan. Now I have received a Form 1099-B from selling it. How do I report this? A: If the special holding period requirements described below are met, the sale of stock is treated generally as capital gain or loss. However, you may have compensation income if: 1. The option price of the stock was below the stock's fair market value at the time the option was granted, or 2. You did not meet either or both of the holding period requirement. The holding period requirements are that you must hold the stock for more than 2 years from the time the option is granted to you and for more than 1 year from when the stock was transferred to you. If you do not meet either or both of these holding period requirements there is a disqualifying disposition of the stock. The compensation income that you should report in the year of the disqualifying disposition is the excess of the fair market value of the stock on the date the stock was transferred to you over the amount paid for the shares. If the holding period requirements are met, but the option exercise price is below the fair market value of the stock at the time the option was granted, you report the discount as compensation income (wages) when you sell the stock. Generally, this compensation income is the lesser of the excess of the fair market value of the stock on the date of the disposition over the exercise price OR the excess of the fair market value of the stock at the time the option was granted over the exercise price. If the holding period requirements are met and your gain is more than the amount you report as compensation income, the remainder is a capital gain reported on Form 1040, Schedule D. If you sell the stock for less than the amount you paid for it, your loss is a capital loss, and you do not have ordinary income. Q: Should I advise the IRS why amounts reported on Form 1099-B do not agree with my Schedule D for proceeds from short sales of stock not closed by the end of year? A: If you are able to defer the reporting of gain or loss until the year the short sale closes, There are certain notations you can make on you Form 1040, Schedule D, Capital Gains and Losses that will allow you to reconcile your Form 1099-B to your Form 1040, Schedule D and still not recognize the gain or loss from the short sale. Include your name as it appears on the return and your social security number. Q: Do I need to pay taxes on that portion of stock I gained as a result of a split? A: No, you generally do not need to pay tax on the additional shares of stock you received due to the stock split. You will need to adjust basis per share basis of the stock. Your overall cost basis has not changed, but your per share basis has changed. You will have to pay taxes if you have gain when you sell the stock. Gain is the amount by which the proceeds from the sale, minus sales commissions, that exceeds the adjusted basis of the stock sold. Q: I have both purchased and sold shares in a money-market mutual fund. The fund is managed so the share price is constant. All gain is reported as dividends. Do I have to report the sale of these shares? A: Yes, you report the sale of your shares on Form 1040, Schedule D, Capital Gains and Losses. Generally, whenever you sell, exchange, or otherwise dispose of a capital asset, you report it on Schedule D. If the share price were constant, you would have neither a gain nor a loss when you sell shares because you are selling the shares for the same price you purchased them. If you actually owned shares that were later sold, the fund or the broker should have issued a Form 1099-B. That form is issued without regard to whether there is a gain or loss on the sale. It reports a sale or exchange of an investment asset and sales proceeds. Q: How do return of principal payments affect my cost basis when I sell mutual funds? A: A return of principal (or return of capital) reduces your basis in your mutual fund shares. Unlike a dividend or a capital gain distribution, a return of capital is a return of part of your investment (cost). However, basis cannot be reduced below zero. Once your basis reaches zero, any return of principal is capital gain and must be reported on Form 1040 Schedule D, Capital Gains and Losses. Q: How do I calculate the average basis for the sale of mutual fund shares?
A:
In order to figure your gain or loss using an average basis, you
must
have
acquired the shares at various times and prices and have left them on
deposit in an account handled by a custodian or agent who maintains an
account for the acquisition or redemption of these shares. There are two average basis methods: * Single-category method, and * Double-category method. Single-category method. First, add up the cost of all the shares you own in the mutual fund. Divide that result by the total number of shares you own. This gives you your average per share. Multiply that number by the number of shares sold. Double-category method. First, divide your shares into two categories, long-term and short-term. Shares held for 1 year or less are short-term. Shares held for more than 1 year are long-term. Then use the steps above to get an average basis for each category. The average basis for that category is then the basis of each share in the sale from that category. Once you elect to use an average basis method, you must continue to use it for all accounts in the same fund. You must clearly identify on your tax return the average basis method that you have elected to use. You do this identification by including "AVGB" in column (a) of Form 1040, Schedule D, Capital Gains and Losses. Q: If I used an average basis method for shares of one mutual fund I sold, do I have to use it for all mutual funds I sell? A: No, you may use a different method, for shares in a different mutual fund. However, once you have elected to use an average basis method to compute the gain or loss on shares in a mutual fund, you must use that same method for the sale of shares from any account in that same fund. Q: How do I calculate the average cost method of a mutual fund if the fund price splits? A: If your mutual fund splits, or adjusts its price, it is treated like a stock split. Your total basis doesn't change after the split, but since you now own more shares without paying any more money, your per-share basis will decrease. To calculate your per-share basis, divide the total cost that you have invested in the fund (minus any shares previously sold) by the current number of shares that you hold. Q: I received a 1099-DIV showing a capital gain. Why do I have to report capital gains from my mutual funds if I never sold any shares? A: A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. You own shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for its investors is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to you. These are called capital gain distributions, which are distinguished on Form 1099-DIV, from income that is from other profits, called ordinary dividends. Capital gains distribution are taxed as long term capital gains regardless of how long you have owned the shares in the mutual fund. If your capital gains distribution is automatically reinvested, the reinvested amount is the basis of the additional shares purchased.
A: If you own securities, including stocks, and they become totally worthless, you can take a deduction for a loss, but not for a bad debt. The worthless securities are treated as though they were capital assets sold on the last day of the tax year. Report worthless securities on Form 1040, Schedule D, in Part 1 or 2 depending on whether you held the stock short term or long term, and write "Worthless" in the applicable column of Form 1040, Schedule D, Capital Gains and Losses. IRS Publications: Publication 523, Selling Your Home Publication 525, Taxable and Nontaxable Income Publication 550, Investment Income and Expenses Tax Topic 409, Capital Gains and Losses Publication 552, Recordkeeping for Individuals Publication 564, Mutual Fund Distributions Tax Topic 453, Bad Debt Deduction
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