Written by Jennifer Cochran
With the extended July 15th tax deadline past us, now is a great time to think about 2020 tax planning strategies. One area to review each year is the tax impact of capital asset transactions.
In order to effectively plan your investment transactions, you must understand how, under federal tax law, you need to net or “offset” capital gains and losses that you experience. Netting your capital gains and losses can help achieve lucrative tax savings benefits and should be part of your year-end tax strategy if you sell capital assets that result in gains and losses in 2020.
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Capital Gains Rates
The current capital gains tax rates for 2020 are 0% if income is $0 – $40,000, 15% $40,001 – $441,450 and 20% if income is over $441,450 for individuals. If married filing jointly, the rates are 0% if income is $0 – $80,000, 15% $80,001 – $496,600 and 20% if income is over $496,600.
Caution.Although qualified dividends are also taxed at the long-term capital gain rate (a maximum 15 percent), you cannot treat them as long-term capital gains for purposes of netting capital gains and losses. They are taxed independently of that process.
Important Holding Periods
Capital gains are taxed at different rates depending on how long you have held the asset. Capital gains and losses are classified as long-term (you’ve held the property for more than 12 months) or short-term (you’ve held the property for 12 months or less), also depending on how long you hold the property before you sell it. Net capital gain is the amount by which your net long-term capital gain is more than your net short-term capital loss.
Note.Capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 16 of Form 1040.
Netting
Under the basic netting procedure, your total short-term capital gains and losses and your total long-term capital gains and losses must be figured separately.
Note.Netting applies to all capital assets. There is no separate netting of stocks with stocks, for example. However, many individuals find that stocks are the only capital assets they have sold each year on a regular basis.
Your short-term capital losses (including short-term loss carryovers from a prior year) are applied first against your short-term capital gains (which would be taxed as ordinary income tax rates), if any.
If you have a net short-term loss at this point, it would then be applied against your net long-term gain. If you have a net short-term gain after netting against long-term losses, then your short-term gain is taxed at the ordinary income tax rate. The netting process lets you offset your net long-term capital loss against any net short-term capital gain.
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You can deduct from your ordinary income a net capital loss of up to $3,000. You can carry forward any unused net capital loss for an unlimited number of years until it is used up. Unlike a corporation, however, you generally cannot carry a capital loss back to an earlier year (although there are some specific exceptions).
Net short-term capital gain (from assets held for 12 months or less) is taxed at the same rates as your ordinary income. Both long-term and short-term capital losses can always be used to offset capital gains, as well as up to $3,000 of ordinary income. However, an individual can only use $3,000 ($1,500 for married individuals filing separately) of net capital losses left after reducing capital gains by capital losses to offset ordinary income in any one year.
Moreover, if your net capital losses exceed the $3,000 deduction limit, you can deduct $3,000 of your losses against ordinary income and carry over the excess loss to the following year. The excess losses that are carried over can then be netted against capital gains in that year with any excess deductible against ordinary income up to $3,000.
The $3,000 amount has not changed for many years. It is one of the few provisions in the Tax Code that is not indexed for inflation. Bills to increase the allowable amount have been introduced in Congress but so far none has come close to passage.
Example
In 2020, Mary had $30,000 of ordinary income, a net short-term capital loss of $2,000, and a net long-term capital loss of $3,000. Mary’s total capital loss deduction is $5,000. She can use $3,000 of her net losses to offset her ordinary income in 2020, and then carry over the remaining $2,000 of net capital losses to be used in 2021.
Caution.In selling securities, you also may have to contend with what’s known as the “wash sale” rule. This rule prevents you from realizing a capital loss if you engage in buy and sell transactions of “substantially identical” assets within 30 days of each other.
Tax planning is an integral part of your overall financial strategy. Please contact us to discuss how capital assets and other tax planning strategies can help you reach your goals.
Do you want help with your tax planning and business planning? Contact The Whitlock Co. to request a consultation. We serve Kansas City, Springfield, and Joplin in Missouri.
I'm an expert in tax planning, particularly in the area of capital asset transactions, and I can provide comprehensive insights into the concepts discussed in the article written by Jennifer Cochran.
Firstly, it's crucial to understand the tax impact of capital asset transactions, especially when planning for the year-end. The article correctly emphasizes the importance of netting or "offsetting" capital gains and losses under federal tax law to achieve tax savings benefits.
The article touches upon the current capital gains tax rates for 2020, which are categorized based on income levels. This includes the 0% rate for income up to $40,000 ($80,000 for married filing jointly), the 15% rate for income between $40,001 and $441,450 ($80,001 and $496,600 for married filing jointly), and the 20% rate for income over $441,450 ($496,600 for married filing jointly).
A critical aspect of understanding capital gains is the holding period. Capital gains are taxed differently depending on whether the asset has been held for more than 12 months (long-term) or 12 months or less (short-term). This classification is essential in determining the tax rates applied to the gains.
The article rightly mentions that capital gains and losses are reported on Schedule D, Capital Gains and Losses, and then transferred to line 16 of Form 1040. This is standard practice in tax reporting for individuals engaging in capital transactions.
The concept of netting is central to effective tax planning. The article explains the basic netting procedure, where short-term and long-term capital gains and losses are calculated separately. Netting allows individuals to offset short-term losses against short-term gains and then against long-term gains. Any remaining net long-term capital loss can be deducted from ordinary income, up to a limit of $3,000.
Additionally, the article provides an example illustrating how a taxpayer with both short-term and long-term capital losses can deduct up to $3,000 from ordinary income, with any excess loss carried over to the following year.
It's important to note the limitations and rules, such as the wash sale rule mentioned in the article. The wash sale rule prevents the realization of a capital loss if there are buy and sell transactions of "substantially identical" assets within 30 days of each other.
In conclusion, the article covers key aspects of tax planning related to capital asset transactions, including tax rates, holding periods, netting procedures, deduction limits, and important rules like the wash sale rule. For personalized advice and assistance with tax planning, individuals are encouraged to consult with professionals.
