4. Sales and Trades of Investment Property
Introduction
This chapter explains the tax treatment of sales and trades of investment property.
Investment property
This is property that produces investment income. Examples include stocks, bonds, and Treasury bills and notes. Property used in a trade or business is not investment property. Form 1099-B. 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 of Form 1040. For more information, see Form 1099-B transactions under Reporting Capital Gains and Losses, later.
Nominees
If someone receives gross proceeds as a nominee for you, that person will give you a Form 1099-B, which will show gross proceeds received on your behalf. If you receive Form 1099-B that includes gross proceeds belonging to another person, see Nominees later under Reporting Capital Gains and Losses for more information.
Other property transactions
Certain transfers of property are discussed in other IRS publications. These include:
- Sale of your main home, discussed in Publication 523, Selling Your Home,
- Installment sales, covered in Publication 537, Installment Sales,
- Various types of transactions involving business property, discussed in Publication 544, Sales and Other Dispositions of Assets,
- Transfers of property at death, covered in Publication 559, Survivors, Executors, and Administrators, and
- Disposition of an interest in a passive activity, discussed in Publication 925, Passive Activity and At-Risk Rules.
Topics - This chapter discusses:
- What a sale or trade is,
- Basis,
- Adjusted basis,
- Figuring gain or loss,
- Nontaxable trades,
- Capital gains and losses, and
- How to report your gain or loss.
Useful Items - You may want to see:
Publication
Form (and Instructions)
- Schedule D (Form 1040)
Capital Gains and Losses - 6781
Gains and Losses From Section 1256 Contracts and Straddles - 8582
Passive Activity Loss Limitations - 8824
Like-Kind Exchanges
See chapter 5 for information about getting these publications and forms.
What Is a Sale or Trade?
Terms you may need to know (see Glossary):
| Equity option |
| Futures contract |
| Marked to market |
| Nonequity option |
| Options dealer |
| Regulated futures contract |
| Section 1256 contract |
| Short sale |
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 Dividends and Other Corporate Distributions in chapter 1,
- 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 generally is treated as a sale or trade. See Stocks, stock rights, and bonds and Discounted Debt Instruments under Capital or Ordinary Gain or Loss, later. In addition, a significant modification of a bond is treated as a trade of the original bond for a new bond. For details, see Regulations section 1.1001-3.
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.
Trade of investment property for an annuity
The transfer of investment property to a corporation, trust, fund, foundation, or other organization, in exchange for a fixed annuity contract that will make guaranteed annual payments to you for life, is a taxable trade. If the present value of the annuity is more than your basis in the property traded, you have a taxable gain in the year of the trade. Figure the present value of the annuity according to factors used by commercial insurance companies issuing annuities.
Transfer by inheritance
The transfer of property of a decedent to the executor or administrator of the estate, or to the heirs or beneficiaries, is not a sale or other disposition. No taxable gain or deductible loss results from the transfer.
Termination of certain rights and obligations
The cancellation, lapse, expiration, or other termination of a right or obligation (other than a securities futures contract) with respect to property that is a capital asset (or that would be a capital asset if you acquired it) is treated as a sale. Any gain or loss is treated as a capital gain or loss. This rule does not apply to the retirement of a debt instrument. See Redemption or retirement of bonds, earlier.
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. (Claims not due to worthless securities or bad debts generally must be filed within 3 years from the date a return is filed, or 2 years from the date the tax is paid, whichever is later.) For more information about filing a claim, see Publication 556, Examination of Returns, Appeal Rights, and Claims for Refund.
Constructive Sales of Appreciated Financial Positions
You are treated as having made a constructive sale when you enter into certain transactions involving an appreciated financial position (defined later) in stock, a partnership interest, or certain debt instruments. You must recognize gain as if the position were disposed of at its fair market value on the date of the constructive sale. This gives you a new holding period for the position that begins on the date of the constructive sale. Then, when you close the transaction, you reduce your gain (or increase your loss) by the gain recognized on the constructive sale.
Constructive sale
You are treated as having made a constructive sale of an appreciated financial position if you:
- Enter into a short sale of the same or substantially identical property,
- Enter into an offsetting notional principal contract relating to the same or substantially identical property,
- Enter into a futures or forward contract to deliver the same or substantially identical property (including a forward contract that provides for cash settlement), or
- Acquire the same or substantially identical property (if the appreciated financial position is a short sale, an offsetting notional principal contract, or a futures or forward contract).
Exception for nonmarketable securities
You are not treated as having made a constructive sale solely because you entered into a contract for sale of any stock, debt instrument, or partnership interest that is not a marketable security if it settles within 1 year of the date you enter into it.
Exception for certain closed transactions
Do not treat a transaction as a constructive sale if all of the following are true.
- You closed the transaction on or before the 30th day after the end of your tax year.
- You held the appreciated financial position throughout the 60-day period beginning on the date you closed the transaction.
- Your risk of loss was not reduced at any time during that 60-day period by holding certain other positions.
Appreciated financial position
This is any interest in stock, a partnership interest, or a debt instrument (including a futures or forward contract, a short sale, or an option) if disposing of the interest would result in a gain.
Exceptions
An appreciated financial position does not include the following.
- Any position from which all of the appreciation is accounted for under marked to market rules, including section 1256 contracts (described later under Section 1256 Contracts Marked to Market).
- Any position in a debt instrument if:
- The position unconditionally entitles the holder to receive a specified principal amount,
- The interest payments (or other similar amounts) with respect to the position are payable at a fixed rate or a variable rate described in Regulations section 1.860G-1(a)(3), and
- The position is not convertible, either directly or indirectly, into stock of the issuer (or any related person).
- Any hedge with respect to a position described in (2).
Certain trust instruments treated as stock
For the constructive sale rules, an interest in an actively traded trust is treated as stock unless substantially all of the value of the property held by the trust is debt that qualifies for the exception to the definition of an appreciated financial position (explained in (2) above).
Sale of appreciated financial position
A transaction treated as a constructive sale of an appreciated financial position is not treated as a constructive sale of any other appreciated financial position, as long as you continue to hold the original position. However, if you hold another appreciated financial position and dispose of the original position before closing the transaction that resulted in the constructive sale, you are treated as if, at the same time, you constructively sold the other appreciated financial position.
Section 1256 Contracts Marked to Market
If you hold a section 1256 contract at the end of the tax year, you generally must treat it as sold at its fair market value on the last business day of the tax year.
Section 1256 Contract
A section 1256 contract is any:
- Regulated futures contract,
- Foreign currency contract,
- Nonequity option,
- Dealer equity option, or
- Dealer securities futures contract.
Regulated futures contract
This is a contract that:
- Provides that amounts that must be deposited to, or can be withdrawn from, your margin account depend on daily market conditions (a system of marking to market), and
- Is traded on, or subject to the rules of, a qualified board of exchange. A qualified board of exchange is a domestic board of trade designated as a contract market by the Commodity Futures Trading Commission, any board of trade or exchange approved by the Secretary of the Treasury, or a national securities exchange registered with the Securities and Exchange Commission.
Foreign currency contract
This is a contract that:
- Requires delivery of a foreign currency that has positions traded through regulated futures contracts (or settlement of which depends on the value of that type of foreign currency),
- Is traded in the interbank market, and
- Is entered into at arm's length at a price determined by reference to the price in the interbank market.
Nonequity option
This is any listed option (defined later) that is not an equity option. Nonequity options include debt options, commodity futures options, currency options, and broad-based stock index options. A broad-based stock index is based upon the value of a group of diversified stocks or securities (such as the Standard and Poor's 500 index).
Warrants based on a stock index that are economically, substantially identical in all material respects to options based on a stock index are treated as options based on a stock index.
Cash-settled options. Cash-settled options based on a stock index and either traded on or subject to the rules of a qualified board of exchange are nonequity options if the Securities and Exchange Commission (SEC) determines that the stock index is broad based. This rule does not apply to options established before the SEC determines that the stock index is broad based.Listed option
This is any option that is traded on, or subject to the rules of, a qualified board or exchange (as discussed earlier under Regulated futures contract). A listed option, however, does not include an option that is a right to acquire stock from the issuer.
Dealer equity option
This is any listed option that, for an options dealer:
- Is an equity option,
- Is bought or granted by that dealer in the normal course of the dealer's business activity of dealing in options, and
- Is listed on the qualified board of exchange where that dealer is registered.
Equity option
This is any option:
- To buy or sell stock, or
- That is valued directly or indirectly by reference to any stock or narrow-based security index.
Equity options include options on a group of stocks only if the group is a narrow-based stock index.
Dealer securities futures contract
For any dealer in securities futures contracts or options on those contracts, this is a securities futures contract (or option on such a contract) that:
- Is entered into by the dealer (or, in the case of an option, is purchased or granted by the dealer) in the normal course of the dealer's activity of dealing in this type of contract (or option), and
- Is traded on a qualified board or exchange (as defined under Regulated futures contract, earlier.)
Marked to Market Rules
A section 1256 contract that you hold at the end of the tax year will generally be treated as sold at its fair market value on the last business day of the tax year, and you must recognize any gain or loss that results. That gain or loss is taken into account in figuring your gain or loss when you later dispose of the contract, as shown in the example under 60/40 rule, below.
Hedging exception
The marked to market rules do not apply to hedging transactions. See Hedging Transactions, later. 60/40 rule. Under the marked to market system, 60% of your capital gain or loss will be treated as a long-term capital gain or loss, and 40% will be treated as a short-term capital gain or loss. This is true regardless of how long you actually held the property.
Example
On June 23, 2006, you bought a regulated futures contract for $50,000. On December 31, 2006 (the last business day of your tax year), the fair market value of the contract was $57,000. You recognized a $7,000 gain on your 2006 tax return, treated as 60% long-term and 40% short-term capital gain.
On February 2, 2007, you sold the contract for $56,000. Because you recognized a $7,000 gain on your 2006 return, you recognize a $1,000 loss ($57,000 - $56,000) on your 2007 tax return, treated as 60% long-term and 40% short-term capital loss.
Limited partners or entrepreneurs
The 60/40 rule does not apply to dealer equity options or dealer securities futures contracts that result in capital gain or loss allocable to limited partners or limited entrepreneurs (defined later under Hedging Transactions). Instead, these gains or losses are treated as short term.
Terminations and transfers
The marked to market rules also apply if your obligation or rights under section 1256 contracts are terminated or transferred during the tax year. In this case, use the fair market value of each section 1256 contract at the time of termination or transfer to determine the gain or loss. Terminations or transfers may result from any offsetting, delivery, exercise, assignment, or lapse of your obligation or rights under section 1256 contracts.
Loss carryback election
An individual having a net section 1256 contracts loss (defined later) for 2007 can elect to carry this loss back 3 years, instead of carrying it over to the next year. See How To Report, later, for information about reporting this election on your return. The loss carried back to any year under this election cannot be more than the net section 1256 contracts gain in that year. In addition, the amount of loss carried back to an earlier tax year cannot increase or produce a net operating loss for that year. The loss is carried to the earliest carryback year first, and any unabsorbed loss amount can then be carried to each of the next 2 tax years. In each carryback year, treat 60% of the carryback amount as a long-term capital loss and 40% as a short-term capital loss from section 1256 contracts. If only a portion of the net section 1256 contracts loss is absorbed by carrying the loss back, the unabsorbed portion can be carried forward, under the capital loss carryover rules, to the year following the loss. (See Capital Losses under Reporting Capital Gains and Losses, later.) Figure your capital loss carryover as if, for the loss year, you had an additional short-term capital gain of 40% of the amount of net section 1256 contracts loss absorbed in the carryback years and an additional long-term capital gain of 60% of the absorbed loss. In the carryover year, treat any capital loss carryover from losses on section 1256 contracts as if it were a loss from section 1256 contracts for that year.
Net section 1256 contracts loss
This loss is the lesser of:
- The net capital loss for your tax year determined by taking into account only the gains and losses from section 1256 contracts, or
- The capital loss carryover to the next tax year determined without this election.
Net section 1256 contracts gain
This gain is the lesser of:
- The capital gain net income for the carryback year determined by taking into account only gains and losses from section 1256 contracts, or
- The capital gain net income for that year.
Figure your net section 1256 contracts gain for any carryback year without regard to the net section 1256 contracts loss for the loss year or any later tax year.
Traders in section 1256 contracts
Gain or loss from the trading of section 1256 contracts is capital gain or loss subject to the marked to market rules. However, this does not apply to contracts held for purposes of hedging property if any loss from the property would be an ordinary loss.
Treatment of underlying property
The determination of whether an individual's gain or loss from any property is ordinary or capital gain or loss is made without regard to the fact that the individual is actively engaged in dealing in or trading section 1256 contracts related to that property.
How To Report
If you disposed of regulated futures or foreign currency contracts in 2007 (or had unrealized profit or loss on these contracts that were open at the end of 2006 or 2007), you should receive Form 1099-B, or an equivalent statement, from your broker.
Form 6781
Use Part I of Form 6781, Gains and Losses From Section 1256 Contracts and Straddles, to report your gains and losses from all section 1256 contracts that are open at the end of the year or that were closed out during the year. This includes the amount shown in box 11 of Form 1099-B. Then enter the net amount of these gains and losses on Schedule D (Form 1040). Include a copy of Form 6781 with your income tax return. If the Form 1099-B you receive includes a straddle or hedging transaction, defined later, it may be necessary to show certain adjustments on Form 6781. Follow the Form 6781 instructions for completing Part I.
Loss carryback election
To carry back your loss under the election procedures described earlier, file Form 1040X or Form 1045, Application for Tentative Refund, for the year to which you are carrying the loss with an amended Form 6781 and an amended Schedule D attached. Follow the instructions for completing Form 6781 for the loss year to make this election.
Hedging Transactions
The marked to market rules, described earlier, do not apply to hedging transactions. A transaction is a hedging transaction if both of the following conditions are met.
- You entered into the transaction in the normal course of your trade or business primarily to manage the risk of:
- Price changes or currency fluctuations on ordinary property you hold (or will hold), or
- Interest rate or price changes, or currency fluctuations, on your current or future borrowings or ordinary obligations.
- You clearly identified the transaction as being a hedging transaction before the close of the day on which you entered
into it.
This hedging transaction exception does not apply to transactions entered into by or for any syndicate. A syndicate is a partnership, S corporation, or other entity (other than a regular corporation) that allocates more than 35% of its losses to limited partners or limited entrepreneurs. A limited entrepreneur is a person who has an interest in an enterprise (but not as a limited partner) and who does not actively participate in its management. However, an interest is not considered held by a limited partner or entrepreneur if the interest holder actively participates (or did so for at least 5 full years) in the management of the entity, or is the spouse, child (including a legally adopted child), grandchild, or parent of an individual who actively participates in the management of the entity.
Hedging loss limit
If you are a limited partner or entrepreneur in a syndicate, the amount of a hedging loss you can claim is limited. A “hedging loss” is the amount by which the allowable deductions in a tax year that resulted from a hedging transaction (determined without regard to the limit) are more than the income received or accrued during the tax year from this transaction. Any hedging loss that is allocated to you for the tax year is limited to your taxable income for that year from the trade or business in which the hedging transaction occurred. Ignore any hedging transaction items in determining this taxable income. If you have a hedging loss that is disallowed because of this limit, you can carry it over to the next tax year as a deduction resulting from a hedging transaction. If the hedging transaction relates to property other than stock or securities, the limit on hedging losses applies if the limited partner or entrepreneur is an individual. The limit on hedging losses does not apply to any hedging loss to the extent that it is more than all your unrecognized gains from hedging transactions at the end of the tax year that are from the trade or business in which the hedging transaction occurred. The term “unrecognized gain” has the same meaning as defined under Straddles, later.
Sale of property used in a hedge
Once you identify personal property as being part of a hedging transaction, you must treat gain from its sale or exchange as ordinary income, not capital gain.
Self-Employment Income
Gains and losses derived in the ordinary course of a commodity or option dealer's trading in section 1256 contracts and property related to these contracts are included in net earnings from self-employment. In addition, the rules relating to contributions to self-employment retirement plans apply. For information on retirement plan contributions, see Publication 560, Retirement Plans for Small Business, and Publication 590, Individual Retirement Arrangements (IRAs).
Basis of Investment Property
Terms you may need to know (see Glossary):
| Basis |
| Fair market value |
| Original issue discount (OID) |
Basis is a way of measuring your investment in property for tax purposes. You must know the basis of your property to determine whether you have a gain or loss on its sale or other disposition.
Investment property you buy normally has an original basis equal to its cost. If you get property in some way other than buying it, such as by gift or inheritance, its fair market value may be important in figuring the basis.
Cost Basis
The basis of property you buy is usually its cost. The cost is the amount you pay in cash, debt obligations, or other property or services.
Unstated interest
If you buy property on a time-payment plan that charges little or no interest, the basis of your property is your stated purchase price, minus the amount considered to be unstated interest. You generally have unstated interest if your interest rate is less than the applicable federal rate. For more information, see Unstated Interest and Original Issue Discount (OID) in Publication 537.
Basis Other Than Cost
There are times when you must use a basis other than cost. In these cases, you may need to know the property's fair market value or the adjusted basis of the previous owner.
Fair market value
This 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. Sales of similar property, around the same date, may be helpful in figuring fair market value.
Property Received for Services
If you receive investment property for services, you must include the property's fair market value in income. The amount you include in income then becomes your basis in the property. If the services were performed for a price that was agreed to beforehand, this price will be accepted as the fair market value of the property if there is no evidence to the contrary.
Restricted property
If you receive, as payment for services, property that is subject to certain restrictions, your basis in the property generally is its fair market value when it becomes substantially vested. Property becomes substantially vested when it is transferable or is no longer subject to substantial risk of forfeiture, whichever happens first. See Restricted Property in Publication 525 for more information.
Bargain purchases
If you buy investment property at less than fair market value, as payment for services, you must include the difference in income. Your basis in the property is the price you pay plus the amount you include in income.
Property Received in Taxable Trades
If you received investment property in trade for other property, the basis of the new property is its fair market value at the time of the trade unless you received the property in a nontaxable trade.
Example
You trade A Company stock for B Company stock having a fair market value of $1,200. If the adjusted basis of the A Company stock is less than $1,200, you have a taxable gain on the trade. If the adjusted basis of the A Company stock is more than $1,200, you have a deductible loss on the trade. The basis of your B Company stock is $1,200. If you later sell the B Company stock for $1,300, you will have a gain of $100.
Property Received in Nontaxable Trades
If you have a nontaxable trade, you do not recognize gain or loss until you dispose of the property you received in the trade. See Nontaxable Trades, later.
The basis of property you received in a nontaxable or partly nontaxable trade is generally the same as the adjusted basis of the property you gave up. Increase this amount by any cash you paid, additional costs you had, and any gain recognized. Reduce this amount by any cash or unlike property you received, any loss recognized, and any liability of yours that was assumed or treated as assumed.
Property Received From Your Spouse
If property is transferred to you from your spouse (or former spouse, if the transfer is incident to your divorce), your basis is the same as your spouse's or former spouse's adjusted basis just before the transfer. See Transfers Between Spouses, later.
Recordkeeping. The transferor must give you the records necessary to determine the adjusted basis and holding period of the property as of the date of the transfer.Property Received as a Gift
To figure your basis in property that you received as a gift, you must know its adjusted basis to the donor just before it was given to you, its fair market value at the time it was given to you, the amount of any gift tax paid on it, and the date it was given to you.
Fair market value less than donor's adjusted basis. If the fair market value of the property at the time of the gift was less than the donor's adjusted basis just before the gift, your basis for gain on its sale or other disposition is the same as the donor's adjusted basis plus or minus any required adjustments to basis during the period you hold the property. Your basis for loss is its fair market value at the time of the gift plus or minus any required adjustments to basis during the period you hold the property.No gain or loss
If you use the basis for figuring a gain and the result is a loss, and then use the basis for figuring a loss and the result is a gain, you will have neither a gain nor a loss.
Example
You receive a gift of investment property having an adjusted basis of $10,000 at the time of the gift. The fair market value at the time of the gift is $9,000. You later sell the property for $9,500. You have neither gain nor loss. Your basis for figuring gain is $10,000, and $9,500 minus $10,000 results in a $500 loss. Your basis for figuring loss is $9,000, and $9,500 minus $9,000 results in a $500 gain.
Gift received before 1977
If you received property as a gift before 1977, your basis in the property is the donor's adjusted basis increased by the total gift tax paid on the gift. However, your basis cannot be more than the fair market value of the gift at the time it was given to you.
Example
You were given XYZ Company stock in 1976. At the time of the gift, the stock had a fair market value of $21,000. The donor's adjusted basis was $20,000. The donor paid a gift tax of $500 on the gift. Your basis for gain or loss is $20,500, the donor's adjusted basis plus the amount of gift tax paid.
Example
The facts are the same as in Example 1 except that the gift tax paid was $1,500. Your basis is $21,000, the donor's adjusted basis plus the gift tax paid, but limited to the fair market value of the stock at the time of the gift.
Gift received after 1976
If you received property as a gift after 1976, your basis is the donor's adjusted basis increased by the part of the gift tax paid that was for the net increase in value of the gift. You figure this part by multiplying the gift tax paid on the gift by a fraction. The numerator (top part) is the net increase in value of the gift and the denominator (bottom part) is the amount of the gift. The net increase in value of the gift is the fair market value of the gift minus the donor's adjusted basis. The amount of the gift is its value for gift tax purposes after reduction by any annual exclusion and marital or charitable deduction that applies to the gift.
Example
In 2007, you received a gift of property from your mother. At the time of the gift, the property had a fair market value of $101,000 and an adjusted basis to her of $40,000. The amount of the gift for gift tax purposes was $89,000 ($101,000 minus the $12,000 annual exclusion), and your mother paid a gift tax of $21,000. You figure your basis in the following way:
| Fair market value | $101,000 |
| Minus: Adjusted basis | 40,000 |
| Net increase in value of gift | $61,000 |
| Gift tax paid | $21,000 |
| Multiplied by .685 ($61,000 ÷ $89,000) | .685 |
| Gift tax due to net increase in value | $14,385 |
| Plus: Adjusted basis of property to your mother | 40,000 |
| Your basis in the property | $54,385 |
Part sale, part gift
If you get property in a transfer that is partly a sale and partly a gift, your basis is the larger of the amount you paid for the property or the transferor's adjusted basis in the property at the time of the transfer. Add to that amount the amount of any gift tax paid on the gift, as described in the preceding discussion. For figuring loss, your basis is limited to the property's fair market value at the time of the transfer.
Gift tax information
For information on gift tax, see Publication 950, Introduction to Estate and Gift Taxes.
Property Received as Inheritance
If you inherited property, your basis in that property generally is its fair market value (its appraised value on the federal estate tax return) on:
- The date of the decedent's death, or
- The later alternate valuation date if the estate qualifies for, and elects to use, alternate valuation.
If no federal estate tax return was filed, use the appraised value on the date of death for state inheritance or transmission taxes.
Appreciated property you gave the decedent
Your basis in certain appreciated property that you inherited is the decedent's adjusted basis in the property immediately before death rather than its fair market value. This applies to appreciated property that you or your spouse gave the decedent as a gift during the one-year period ending on the date of death. Appreciated property is any property whose fair market value on the day you gave it to the decedent was more than its adjusted basis.
More information
See Publication 551, Basis of Assets, for more information on the basis of inherited property, including community property, property held by a surviving tenant in a joint tenancy or tenancy by the entirety, a qualified joint interest, and a farm or closely held business.
Adjusted Basis
Before you can figure any gain or loss on a sale, exchange, or other disposition of property or figure allowable depreciation, depletion, or amortization, you usually must make certain adjustments (increases and decreases) to the basis of the property. The result of these adjustments to the basis is the adjusted basis.
Adjustments to the basis of stocks and bonds are explained in the following discussion. For information about other adjustments to basis, see Publication 551.
Stocks and Bonds
The basis of stocks or bonds you own generally is the purchase price plus the costs of purchase, such as commissions and recording or transfer fees. If you acquired stock or bonds other than by purchase, your basis is usually determined by fair market value or the previous owner's adjusted basis as discussed earlier under Basis Other Than Cost.
The basis of stock must be adjusted for certain events that occur after purchase. For example, if you receive more stock from nontaxable stock dividends or stock splits, you must reduce the basis of your original stock. You must also reduce your basis when you receive nondividend distributions (discussed in chapter 1). These distributions, up to the amount of your basis, are a nontaxable return of capital.
The IRS partners with companies that offer Schedule D software that can import trades from many brokerage firms and accounting software to help you keep track of your adjusted basis in securities. To find out more, go to http://www.irs.gov/efile.Identifying stock or bonds sold
If you can adequately identify the shares of stock or the bonds you sold, their basis is the cost or other basis of the particular shares of stock or bonds.
Adequate identification
You will make an adequate identification if you show that certificates representing shares of stock from a lot that you bought on a certain date or for a certain price were delivered to your broker or other agent.
Broker holds stock
If you have left the stock certificates with your broker or other agent, you will make an adequate identification if you:
- Tell your broker or other agent the particular stock to be sold or transferred at the time of the sale or transfer, and
- Receive a written confirmation of this from your broker or other agent within a reasonable time.
Stock identified this way is the stock sold or transferred even if stock certificates from a different lot are delivered to the broker or other agent.
Single stock certificate
If you bought stock in different lots at different times and you hold a single stock certificate for this stock, you will make an adequate identification if you:
- Tell your broker or other agent the particular stock to be sold or transferred when you deliver the certificate to your broker or other agent, and
- Receive a written confirmation of this from your broker or other agent within a reasonable time.
Bonds
These methods of identification also apply to bonds sold or transferred.
Identification not possible
If you buy and sell securities at various times in varying quantities and you cannot adequately identify the shares you sell, the basis of the securities you sell is the basis of the securities you acquired first. Except for certain mutual fund shares, discussed later, you cannot use the average price per share to figure gain or loss on the sale of the shares.
Example
You bought 100 shares of stock of XYZ Corporation in 1994 for $10 a share. In January 1995 you bought another 200 shares for $11 a share. In July 1995 you gave your son 50 shares. In December 1997 you bought 100 shares for $9 a share. In April 2007 you sold 130 shares. You cannot identify the shares you disposed of, so you must use the stock you acquired first to figure the basis. The shares of stock you gave your son had a basis of $500 (50 × $10). You figure the basis of the 130 shares of stock you sold in 2007 as follows:
| 50 shares (50 × $10) balance of stock bought in 1994 | $ 500 |
| 80 shares (80 × $11) stock bought in January 1995 | 880 |
| Total basis of stock sold in 2007 | $1,380 |
Shares in a mutual fund or REIT
The basis of shares in a mutual fund (or other regulated investment company) or a real estate investment trust (REIT) is generally figured in the same way as the basis of other stock.
Mutual fund load charges
Your cost basis in a mutual fund often includes a sales fee, also known as a load charge. But, in certain cases, you cannot include the entire amount of a load charge in your basis if the charge gives you a reinvestment right. For more information, see Publication 564.
Choosing average basis for mutual fund shares
You can choose to use the average basis of mutual fund shares if you acquired the shares at various times and prices and left them on deposit in an account kept by a custodian or agent. The methods you can use to figure average basis are explained in Publication 564.
Undistributed capital gains
If you had to include in your income any undistributed capital gains of the mutual fund or REIT, increase your basis in the stock by the difference between the amount you included and the amount of tax paid for you by the fund or REIT. See Undistributed capital gains of mutual funds and REITs under Capital Gain Distributions in chapter 1.
Automatic investment service
If you participate in an automatic investment service, your basis for each share of stock, including fractional shares, bought by the bank or other agent is the purchase price plus a share of the broker's commission.
Dividend reinvestment plans
If you participate in a dividend reinvestment plan and receive stock from the corporation at a discount, your basis is the full fair market value of the stock on the dividend payment date. You must include the amount of the discount in your income.
Public utilities
If, before 1986, you excluded from income the value of stock you had received under a qualified public utility reinvestment plan, your basis in that stock is zero.
Stock dividends
Stock dividends are distributions made by a corporation of its own stock. Generally, stock dividends are not taxable to you. However, see Distributions of Stock and Stock Rights under Nondividend Distributions in chapter 1 for some exceptions. If the stock dividends are not taxable, you must divide your basis for the old stock between the old and new stock.
New and old stock identical
If the new stock you received as a nontaxable dividend is identical to the old stock on which the dividend was declared, divide the adjusted basis of the old stock by the number of shares of old and new stock. The result is your basis for each share of stock.
Example
You owned one share of common stock that you bought for $45. The corporation distributed two new shares of common stock for each share held. You then had three shares of common stock. Your basis in each share is $15 ($45 ÷ 3).
Example
You owned two shares of common stock. You had bought one for $30 and the other for $45. The corporation distributed two new shares of common stock for each share held. You had six shares after the distribution—three with a basis of $10 each ($30 ÷ 3) and three with a basis of $15 each ($45 ÷ 3).
New and old stock not identical
If the new stock you received as a nontaxable dividend is not identical to the old stock on which it was declared, the basis of the new stock is calculated differently. Divide the adjusted basis of the old stock between the old and the new stock in the ratio of the fair market value of each lot of stock to the total fair market value of both lots on the date of distribution of the new stock.
Example
You bought a share of common stock for $100. Later, the corporation distributed a share of preferred stock for each share of common stock held. At the date of distribution, your common stock had a fair market value of $150 and the preferred stock had a fair market value of $50. You figure the basis of the old and new stock by dividing your $100 basis between them. The basis of your common stock is $75 ($150/$200 × $100), and the basis of the new preferred stock is $25 ($50/$200 × $100).
Stock bought at various times
Figure the basis of stock dividends received on stock you bought at various times and at different prices by allocating to each lot of stock the share of the stock dividends due to it.
Taxable stock dividends
If your stock dividend is taxable when you receive it, the basis of your new stock is its fair market value on the date of distribution. The basis of your old stock does not change.
Stock splits
Figure the basis of stock splits in the same way as stock dividends if identical stock is distributed on the stock held.
Stock rights
A stock right is a right to acquire a corporation's stock. It may be exercised, it may be sold if it has a market value, or it may expire. Stock rights are rarely taxable when you receive them. See Distributions of Stock and Stock Rights under Nondividend Distributions in chapter 1.
Taxable stock rights
If you receive stock rights that are taxable, the basis of the rights is their fair market value at the time of distribution. The basis of the old stock does not change.
Nontaxable stock rights
If you receive nontaxable stock rights and allow them to expire, they have no basis. If you exercise or sell the nontaxable stock rights and if, at the time of distribution, the stock rights had a fair market value of 15% or more of the fair market value of the old stock, you must divide the adjusted basis of the old stock between the old stock and the stock rights. Use a ratio of the fair market value of each to the total fair market value of both at the time of distribution. If the fair market value of the stock rights was less than 15%, their basis is zero. However, you can choose to divide the basis of the old stock between the old stock and the stock rights. To make the choice, attach a statement to your return for the year in which you received the rights, stating that you choose to divide the basis of the stock.
Basis of new stock
If you exercise the stock rights, the basis of the new stock is its cost plus the basis of the stock rights exercised.
Example
You own 100 shares of ABC Company stock, which cost you $22 per share. The ABC Company gave you 10 nontaxable stock rights that would allow you to buy 10 more shares at $26 per share. At the time the stock rights were distributed, the stock had a market value of $30, not including the stock rights. Each stock right had a market value of $3. The market value of the stock rights was less than 15% of the market value of the stock, but you chose to divide the basis of your stock between the stock and the rights. You figure the basis of the rights and the basis of the old stock as follows:
| 100 shares × $22 = $2,200, basis of old stock | |
| 100 shares × $30 = $3,000, market value of old stock | |
| 10 rights × $3 = $30, market value of rights | |
| ($3,000 ÷ $3,030) × $2,200 = $2,178.22, new basis of old stock | |
| ($30 ÷ $3,030) × $2,200 = $21.78, basis of rights |
If you sell the rights, the basis for figuring gain or loss is $2.18 ($21.78 ÷ 10) per right. If you exercise the rights, the basis of the stock you acquire is the price you pay ($26) plus the basis of the right exercised ($2.18), or $28.18 per share. The remaining basis of the old stock is $21.78 per share.
Investment property received in liquidation
In general, if you receive investment property as a distribution in partial or complete liquidation of a corporation and if you recognize gain or loss when you acquire the property, your basis in the property is its fair market value at the time of the distribution.
S corporation stock
You must increase your basis in stock of an S corporation by your pro rata share of the following items.
- All income items of the S corporation, including tax-exempt income, that are separately stated and passed through to you as a shareholder.
- The nonseparately stated income of the S corporation.
- The amount of the deduction for depletion (other than oil and gas depletion) that is more than the basis of the property being depleted.
- Distributions by the S corporation that were not included in your income.
- All loss and deduction items of the S corporation that are separately stated and passed through to you.
- Any nonseparately stated loss of the S corporation.
- Any expense of the S corporation that is not deductible in figuring its taxable income and not properly chargeable to a capital account.
- The amount of your deduction for depletion of oil and gas wells to the extent the deduction is not more than your share of the adjusted basis of the wells.
Specialized small business investment company stock or partnership interest
If you bought this stock or interest as replacement property for publicly traded securities you sold at a gain, you must reduce the basis of the stock or interest by the amount of any postponed gain on that sale. See Rollover of Gain From Publicly Traded Securities, later.
Qualified small business stock
If you bought this stock as replacement property for other qualified small business stock you sold at a gain, you must reduce the basis of this replacement stock by the amount of any postponed gain on the earlier sale. See Gains on Qualified Small Business Stock, later.
Short sales
If you cannot deduct payments you make to a lender in lieu of dividends on stock used in a short sale, the amount you pay to the lender is a capital expense, and you must add it to the basis of the stock used to close the short sale. See Payments in lieu of dividends, later, for information about deducting payments in lieu of dividends.
Premiums on bonds
If you buy a bond at a premium, the premium is treated as part of your basis in the bond. If you choose to amortize the premium paid on a taxable bond, you must reduce the basis of the bond by the amortized part of the premium each year over the life of the bond. Although you cannot deduct the premium on a tax-exempt bond, you must amortize it to determine your adjusted basis in the bond. You must reduce the basis of the bond by the premium you amortized for the period you held the bond. See Bond Premium Amortization in chapter 3 for more information.
Market discount on bonds
If you include market discount on a bond in income currently, increase the basis of your bond by the amount of market discount you include in your income. See Market Discount Bonds in chapter 1 for more information.
Bonds purchased at par value
A bond purchased at par value (face amount) has no premium or discount. When you sell or otherwise dispose of the bond, you figure the gain or loss by comparing the bond proceeds to the purchase price of the bond.
Example
You purchased a bond several years ago for its par value of $10,000. You sold the bond this year for $10,100. You have a gain of $100. However, if you had sold the bond for $9,900, you would have a loss of $100.
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.
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 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. If a buyer of property issues a debt instrument to the seller of the property, the amount realized is determined by reference to the issue price of the debt instrument, which may or may not be the fair market value of the debt instrument. See Regulations section 1.1001-1(g). However, if the debt instrument was previously issued by a third party (one not part of the sale transaction), the fair market value of the debt instrument is used to determine the amount realized.
Fair market value
Fair market value is the price at which 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 minus $7,000). If you also receive a note for $6,000 that has an issue price of $6,000, your gain is $9,000 ($10,000 plus $6,000 minus $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 plus $8,000). Your gain is $22,000 ($28,000 minus $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 and 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 No gain or loss in the discussion on the basis of property you received as a gift under Basis Other Than Cost, earlier.
Nontaxable Trades
This section discusses trades that generally do not result in a taxable gain or a 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 under Corporate Stocks.
- 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. If you received the replacement property before the end of the 45-day period, you automatically are treated as having met the 45-day written notice requirement.
- 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 the like property, and the preceding 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
You figure your basis in property received in a nontaxable or partly nontaxable trade as explained under Basis Other Than Cost, earlier.
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.
Example
On April 19, 2007, KP1 Corporation was acquired by KP2 Corporation. You held 100 shares of KP1 stock with a basis of $3,500. As a result of the acquisition, you received 70 shares of KP2 stock in exchange for your KP1 stock. You do not recognize gain or loss on the transaction. Your basis in the 70 shares of the new stock is still $3,500.
Example
On July 27, 2007, RGB Corporation divests itself of SFH Corporation. You hold 75 shares of RGB stock with a basis of $5,400. You receive 25 shares of SFH stock as a result of the spin-off. You do not recognize any gain or loss on the transaction. You receive information from RGB Corporation that your basis in SFH stock is equal to 10.9624% of your basis in RGB stock ($5,400). Thus, your basis in SFH stock is $592.00. Your basis in RGB stock (after the spin-off) is $4,808 ($5,400 - $592).
Note.
In the case of a spin-off, the divesting corporation should send you information that includes details on how to allocate basis between the old and new stock. Keep this information until the period of limitations expires for the year in which you dispose of the stock in a taxable disposition. Usually, this is 3 years from the date the return was due or filed, or 2 years from the date the tax was paid, whichever is later.
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. If you receive cash for fractional shares, see Fractional shares under Distributions of stock and stock rights in chapter 1.
Money or other property received
If in an otherwise nontaxable trade you receive money or other property in addition to stock, then your gain on the trade, if any, is taxed, but only up to the amount of the money or other property. Any loss is not recognized. If you received cash for fractional shares, see Fractional shares under Distributions of Stock and Stock Rights in chapter 1.
Nonqualified preferred stock
Nonqualified preferred stock is generally treated as property other than stock. Generally, this applies to preferred stock with one or more of the following features.
- The holder has the right to require the issuer or a related person to redeem or purchase the stock.
- The issuer or a related person is required to redeem or purchase the stock.
- The issuer or a related person has the right to redeem the stock, and on the issue date, it is more likely than not that the right will be exercised.
- The dividend rate on the stock varies with reference to interest rates, commodity prices, or similar indices.
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.
Example
In November, you bought for $1 a right issued by XYZ Corporation entitling you, on payment of $99, to subscribe to a bond issued by that corporation.
On December 2, you subscribed to the bond, which was issued on December 9. The bond contained a clause stating that you would receive one share of XYZ Corporation common stock on surrender of one bond and the payment of $50.
Later, you presented the bond and $50 and received one share of XYZ Corporation common stock. You did not have a recognized gain or loss. This is true whether the fair market value of the stock was more or less than $150 on the date of the conversion.
The basis of your share of stock is $150 ($1 + $99 + $50). Your holding period is split. Your holding period for the part based on your ownership of the bond ($100 basis) begins on December 2. Your holding period for the part based on your cash investment ($50 basis) begins on the day after you acquired the share of stock.
Bonds for stock of another corporation
Generally, if you convert the bonds of one corporation into common stock of another corporation, according to the terms of the bond issue, you must recognize gain or loss up to the difference between the fair market value of the stock received and the adjusted basis of the bonds exchanged. In some instances, however, such as trades that are part of mergers or other corporate reorganizations, you will have no recognized gain or loss if certain requirements are met. For more information about the tax consequences of converting securities of one corporation into common stock of another corporation, under circumstances such as those just described, consult the respective corporations and the terms of the bond issue. This information is also available on the prospectus of the bond issue.
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. If you are in a bankruptcy or a similar proceeding and you transfer property to a controlled corporation under a plan, other than a reorganization, you must recognize gain to the extent the stock you receive in the exchange is used to pay off your debts. 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 may have to attach to your return a complete statement of all facts pertinent to the exchange. For details, see Regulations section 1.351-3.
Money or other property received
If, in an otherwise nontaxable trade of property for corporate stock, you also receive money or property other than stock, you may have a taxable gain. However, you are taxed only up to the amount of money plus the fair market value of the other property you receive. The rules for figuring taxable gain in this situation generally follow those for a partly nontaxable exchange discussed earlier under Like-Kind Exchanges. If the property you give up includes depreciable property, the taxable gain may have to be reported as ordinary income because of depreciation. (See chapter 3 of Publication 544.) No loss is recognized. Nonqualified preferred stock (described earlier under Stock for stock of the same corporation) received is generally treated as property other than stock.
Basis of stock or other property received
The basis of the stock you receive is generally the adjusted basis of the property you transfer. Increase this amount by any amount that was treated as a dividend, plus any gain recognized on the trade. Decrease this amount by any cash you received and the fair market value of any other property you received. The basis of any other property you receive is its fair market value on the date of the trade.
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 from an exchange of a portion of an annuity contract for another annuity contract. See Revenue Ruling 2003-76 and Notice 2003-51 in Internal Revenue Bulletin 2003-33. This bulletin is available at www.irs.gov/pub/irs-irbs/irb03-33.pdf.
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
A life insurance company may change from a mutual company to a stock company. This is commonly called demutualization. If you were a policyholder or annuitant of the mutual company, you may have received either stock in the stock company or cash in exchange for your equity interest in the mutual company.
If the demutualization transaction qualifies as a tax-free reorganization under section 368(a)(1) of the Internal Revenue Code, no gain or loss is recognized on the exchange. Your holding period for the new stock includes the period you held an equity interest in the mutual company as a policyholder or annuitant.
If the demutualization transaction does not qualify as a tax-free reorganization under section 368(a)(1) of the Internal Revenue Code, you must recognize a capital gain or loss. Your holding period for the stock does not include the period you held an equity interest in the mutual company.
If you received cash in exchange for your equity interest, you must recognize a capital gain. If you held an equity interest for more than 1 year, your gain is long term.
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.
See the discussion in chapter 1 under U.S. Treasury Bills, Notes, and Bonds for information about income from these investments.
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.
- An installment obligation is transferred in trust. For information on the disposition of an installment obligation, see Publication 537, Installment Sales.
- Certain stock redemptions, which are taxable to a spouse under the tax law, a divorce or separation instrument, or a valid written agreement, discussed in Regulations section 1.1041-2.
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. For more information, see Property Settlements in Publication 504, Divorced or Separated Individuals.
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 in 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 for the year in which the later disposition occurs.
This rule generally does not apply to:
- Dispositions due to the death of either related party,
- Involuntary conversions (see chapter 1 of Publication 544), or
- Trades and later dispositions whose main purpose is not the avoidance of federal income tax.
If a property holder's risk of loss on the property is substantially diminished during any period, that period is not counted in determining whether the property was disposed of within 2 years. The property holder's risk of loss is substantially diminished by:
- The holding of a put on the property,
- The holding by another person of a right to acquire the property, or
- A short sale or any other transaction.
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 that 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 later 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
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
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
Terms you may need to know (see Glossary):
| Call |
| Commodity future |
| Conversion transaction |
| Forward contract |
| Limited partner |
| Listed option |
| Nonequity option |
| Options dealer |
| Put |
| Regulated futures contract |
| Section 1256 contract |
| Straddle |
| Wash sale |
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. For information about determining whether your capital gain or loss is short term or long term, see Holding Period, later. For information about 28% rate gain or loss and unrecaptured section 1250 gain, see Capital Gain Tax Rates under Reporting Capital Gains and Losses, later.