Table of Contents
Capital asset treatment for self-created musical works. Musical compositions and copyrights in musical works are generally not capital assets. However, you can elect to treat those types of property as capital assets. See Capital Asset Treatment for Self-Created Musical Works later.
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.
This chapter discusses the tax consequences of selling or trading investment property. It explains the following.
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What a sale or trade is.
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Figuring gain or loss.
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Nontaxable trades.
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Related party transactions.
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Capital gains or losses.
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Capital assets and noncapital assets.
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Holding period.
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Rollover of gain from publicly traded securities.
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Sales of a main home, covered in chapter 15.
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Installment sales, covered in Publication 537, Installment Sales.
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Transactions involving business property, covered in Publication 544, Sales and Other Dispositions of Assets.
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Transfers of property at death, covered in Publication 559, Survivors, Executors, and Administrators.
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Dispositions of an interest in a passive activity, covered in Publication 925, Passive Activity and At-Risk Rules.
Publication
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550 Investment Income and Expenses
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564 Mutual Fund Distributions
Form (and Instructions)
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Schedule D (Form 1040) Capital Gains and Losses
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8824 Like-Kind Exchanges
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).
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.
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The redemption is not essentially equivalent to a dividend (see chapter 8),
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There is a substantially disproportionate redemption of stock,
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There is a complete redemption of all the stock of the corporation owned by the shareholder, or
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The redemption is a distribution in partial liquidation of a corporation.
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.
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.
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).
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).
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.
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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.
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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.
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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.
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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.
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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.
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The property to be received must be received by the earlier of:
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The 180th day after the date on which you transfer the property given up in the trade, or
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The due date, including extensions, for your tax return for the year in which the transfer of the property given up occurs.
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A life insurance contract for another life insurance contract or for an endowment or annuity contract,
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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
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An annuity contract for another annuity contract.
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.
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The recipient spouse or former spouse is a nonresident alien.
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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.
Special rules apply to the sale or trade of property between related parties.
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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.).
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A partnership in which you directly or indirectly own more than 50% of the capital interest or the profits interest.
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A corporation in which you directly or indirectly own more than 50% in value of the outstanding stock. (See Constructive ownership of stock , later.)
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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.
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A grantor and fiduciary, or the fiduciary and beneficiary, of any trust.
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Fiduciaries of two different trusts, or the fiduciary and beneficiary of two different trusts, if the same person is the grantor of both trusts.
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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.
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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.
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Two S corporations if the same persons own more than 50% in value of the outstanding stock of each corporation.
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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.
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An executor and a beneficiary of an estate (except in the case of a sale or trade to satisfy a pecuniary bequest).
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Two corporations that are members of the same controlled group. (Under certain conditions, however, these losses are not disallowed but must be deferred.)
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Two partnerships if the same persons own, directly or indirectly, more than 50% of the capital interests or the profit interests in both partnerships.
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.
This section discusses the tax treatment of gains and losses from different types of investment transactions.
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.
For the most part, everything you own and use for personal purposes, pleasure, or investment is a capital asset. Some examples are:
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Stocks or bonds held in your personal account,
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A house owned and used by you and your family,
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Household furnishings,
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A car used for pleasure or commuting,
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Coin or stamp collections,
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Gems and jewelry, and
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Gold, silver, or any other metal.
Any property you own is a capital asset, except the following noncapital assets.
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Property held mainly for sale to customers or property that will physically become a part of the merchandise that is for sale to customers.
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Depreciable property used in your trade or business, even if fully depreciated.
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Real property used in your trade or business.
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A copyright, a literary, musical, or artistic composition, a letter or memorandum, or similar property—
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Created by your personal efforts,
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Prepared or produced for you (in the case of a letter, memorandum, or similar property), or
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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.
For an exception to this rule, see Capital Asset Treatment for Self-Created Musical Works later.
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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).
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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.
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Certain commodities derivative financial instruments held by commodities derivatives dealers.
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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.
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Supplies of a type you regularly use or consume in the ordinary course of your trade or business.
Investment property is a capital asset. Any gain or loss from its sale or trade is generally a capital gain or loss.
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.
You can elect to treat musical compositions and copyrights in musical works as capital assets if you sell or exchange them in tax years beginning after May 17, 2006, and:
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Your personal efforts created the property, or
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You acquired the property 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.
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.
Example.
On July 1, 1996, 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, 2007) 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.
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The lender is not in the business of lending money.
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The amount of the loan, plus the amount of any outstanding prior loans, is $10,000 or less.
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Avoiding federal tax is not one of the principal purposes of the loan.
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.
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Ordinary loss.
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Casualty loss.
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Nonbusiness bad debt (short-term capital loss).
For more information, see
Deposit in Insolvent or Bankrupt Financial Institution, in chapter 4 of Publication 550.
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.
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 section 1244 stock is a capital gain if the stock is a capital asset in your hands. Report the gain on Schedule D (Form 1040). See Losses on Section 1244 (Small Business) Stock in chapter 4 of Publication 550.
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.
Example.
If you bought investment property on February 5, 2006, and sold it on February 5, 2007, 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, 2007, your holding period is more than 1 year and you will have a long-term capital gain or loss.
Example.
You are a cash method, calendar year taxpayer. You sold stock at a gain on December 29, 2007. 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 4, 2008. You received payment of the sales price on that same day. Report your gain on your 2007 return, even though you received the payment in 2008. 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 2007 return.
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.
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A description of the debt, including the amount, and the date it became due,
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The name of the debtor, and any business or family relationship between you and the debtor,
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The efforts you made to collect the debt, and
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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.
You cannot deduct losses from sales or trades of stock or securities in a wash sale.
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:
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Buy substantially identical stock or securities,
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Acquire substantially identical stock or securities in a fully taxable trade, or
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Acquire a contract or option to buy substantially identical stock or securities.
If your loss was disallowed because of the wash sale rules, add the disallowed loss to the cost of the new stock or securities. The result is your basis in the new stock or securities. This adjustment postpones the loss deduction until the disposition of the new stock or securities.
For more information, see Wash Sales, in chapter 4 of Publication 550.
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.
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You sell publicly traded securities at a gain. Publicly traded securities are securities traded on an established securities market.
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Your gain from the sale is a capital gain.
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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.
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The amount realized on the sale, minus
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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.
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$50,000 ($25,000 if you are married and file a separate return), or
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$500,000 ($250,000 if you are married and file a separate return), minus the amount of gain you postponed for all earlier years.
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