Income and Assets · Property, real and personal

Capital gains and losses

Section 1(h) cannot be read on its own. Its 0 percent band is defined by reference to income “taxed at a rate below 25 percent” and its 15 percent band by reference to a rate “below 39.6 percent” — two brackets that have not existed since 2017. Section 1(j)(5) substitutes defined dollar amounts for both, and those amounts are what the Revenue Procedure adjusts each year. A practitioner reading § 1(h) alone will find nothing that maps onto the current rate schedule.

The rule

A capital asset is defined by what it is not. The term means property held by the taxpayer, whether or not connected with a trade or business, but does not include inventory or property held primarily for sale to customers; depreciable property used in the trade or business, or real property so used; certain self-created intangibles; trade accounts and notes receivable; certain government publications; some commodities derivatives; hedging transactions; and supplies consumed in the business (IRC § 1221(a)(1)–(8)).

Self-created property is not a capital asset in the creator’s hands. A patent, invention, model or design, secret formula or process, copyright, or literary, musical or artistic composition is excluded where held by the taxpayer whose personal efforts created it, or by a taxpayer taking a carryover basis from that person (IRC § 1221(a)(3)). There is one escape, and it is narrow: at the taxpayer’s election, paragraphs (a)(1) and (a)(3) do not apply to musical compositions or copyrights in musical works sold or exchanged by such a taxpayer (§ 1221(b)(3)). Music has an election; the novel and the painting do not.

The holding period is measured to the day. Long term means held more than one year; short term means not more than one year (IRC § 1222(1)–(4)). Property acquired on a given date therefore first becomes long term when sold on the day after the anniversary.

Losses are capped, and the cap has never moved. For a taxpayer other than a corporation, capital losses are allowed to the extent of capital gains, plus the lower of a fixed statutory allowance — halved for a married individual filing separately — or the excess of losses over gains (IRC § 1211(b)); the amounts are in the table below. The figure is not indexed, has stood since 1986, and is not doubled on a joint return: the smaller figure is a halving for separate filers, not the joint amount halved.

The excess carries forward with its character. A net short-term capital loss in excess of net long-term capital gain is a short-term capital loss in the succeeding year, and the long-term excess is a long-term capital loss in the succeeding year (IRC § 1212(b)(1)). There is no expiry and no carryback for individuals.

The rate structure, read correctly. Section 1(h)(1) taxes adjusted net capital gain at 0 percent up to one amount, 15 percent up to a second, and 20 percent above it (§ 1(h)(1)(B)–(D)) — but only once § 1(j)(5)(A) has substituted “below the maximum zero rate amount” and “below the maximum 15-percent rate amount” for the obsolete bracket references. Adjusted net capital gain is net capital gain reduced by unrecaptured section 1250 gain and by 28-percent rate gain, plus qualified dividend income (§ 1(h)(3)).

Two categories sit outside that schedule. Unrecaptured section 1250 gain is taxed at 25 percent (§ 1(h)(1)(E)). 28-percent rate gain — collectibles gain and § 1202 gain, net of collectibles loss, the net short-term capital loss and the long-term capital loss carried forward — is taxed at 28 percent (§ 1(h)(1)(F), (h)(4)). A collectible takes its § 408(m) meaning without regard to paragraph (3).

Qualified dividends ride along, if the stock was held long enough. Net capital gain is increased by qualified dividend income (IRC § 1(h)(11)(A)). The dividend is disqualified where the § 246(c) holding period is not met, applied by substituting 60 days for 45 days and a 121-day period for the 91-day period (§ 1(h)(11)(B)(iii)(I)) — so the stock must be held more than 60 days in that window. For preference dividends attributable to periods aggregating more than 366 days, § 246(c)(2) substitutes 90 days and a 181-day period.

Wash sales. No deduction is allowed for a loss on stock or securities where, within the period beginning 30 days before and ending 30 days after the sale, the taxpayer acquires — or contracts or options to acquire — substantially identical stock or securities (IRC § 1091(a)). The disallowed loss is not lost: the replacement takes the basis of the shares sold, adjusted for the price difference (§ 1091(d)). The section speaks of stock or securities, and of contracts or options to acquire or sell them.

Two regimes bypass the holding period. Each § 1256 contract held at year end is treated as sold at fair market value on the last business day, and gain or loss on it is split 40 percent short-term and 60 percent long-term however long it was held (IRC § 1256(a)(1), (3)). And a capital gain dividend from a regulated investment company is treated by the shareholder as gain from a capital asset held more than one year, whatever their holding period in the fund (IRC § 852(b)(3)(B)).

Digital assets are property. Virtual currency is treated as property and general property principles apply; it is not currency and cannot generate foreign currency gain or loss (Notice 2014-21, A-1, A-2). For broker reporting, a digital asset is a digital representation of value recorded on a cryptographically secured distributed ledger (IRC § 6045(g)(3)(D)).

And a surtax sits above all of it. Net investment income tax is 3.8 percent of the lesser of net investment income or the excess of modified adjusted gross income over the threshold amount (IRC § 1411(a)(1), (b)).

Current figures

How it works in practice

Net within each holding period first, then across them. Short-term gains against short-term losses, long-term against long-term, and only then the two results against each other. The order matters because the character that survives is what reaches the rate schedule, and because a net short-term capital loss reduces 28-percent rate gain under § 1(h)(4)(B)(ii) before it does anything else.

Then sort the long-term result into its buckets. Unrecaptured section 1250 gain and 28-percent rate gain come out of net capital gain first; qualified dividends go in; the remainder is adjusted net capital gain and takes the 0, 15 and 20 percent rates. A taxpayer with a modest income and a large gain will use all three bands in one year, and the bands are measured against taxable income, not against the gain.

Watch the interaction with the surtax. The § 1411 thresholds are lower than the 20 percent breakpoint and are not indexed, so a taxpayer can sit well inside the 15 percent band and still pay the surtax on top.

For a client with a large loss, be honest about the arithmetic: at the annual allowance a six-figure net capital loss takes decades to absorb unless gains appear. Harvesting gains to use the carryforward is often the better advice.

How this has changed

Section 1(h) was left pointing at brackets that no longer exist. Its subparagraph (B)(i) speaks of income taxed at a rate below 25 percent and (C)(ii)(I) of a rate below 39.6 percent, neither of which has been in the rate schedule since 2017. Section 1(j)(5)(A) fixes this by textual substitution rather than by amending § 1(h), so the operative amounts live in § 1(j)(5)(B) and are adjusted annually. This is not a drafting oversight of the kind that can be ignored — it is the reason § 1(h) alone is unusable, and it is worth knowing which provision to cite.

Digital assets acquired a reporting regime without acquiring a character change. Notice 2014-21 has treated virtual currency as property since 2014, and that has not moved. What changed is broker reporting: § 6045(g)(3)(D) now defines a digital asset for that purpose. Note what the reporting does not do — it does not make a digital asset a security, and IRC § 1091 by its terms reaches “shares of stock or securities” and contracts or options to acquire or sell them. Nothing opened for this page extends the wash sale rule to digital assets.

The loss allowance has been overtaken by inflation more thoroughly than almost any figure in the Code. It has stood at the same amount since the Tax Reform Act of 1986 with no cost-of-living clause, so the real relief it gives has fallen by roughly threefold. This is the same asymmetry recorded elsewhere: figures announced each year in the Revenue Procedure move, and round statutory numbers written into relief provisions do not.

Section 1221(a)(3) was widened in 2017 to add patents, inventions, models or designs, and secret formulas or processes to the self-created property excluded from capital asset treatment. The musical works election in § 1221(b)(3) was not extended to them, so the asymmetry between music and every other creative output is now wider than it was.

Exam focus

Expect the netting order to be tested with a fact pattern that produces different answers if you net across holding periods first. Short against short, long against long, then the two.

Expect the loss limit with a joint return in the facts, testing whether you double it. You do not.

Expect the holding period as a date question. Purchase date plus one year plus one day.

Expect qualified dividends with a holding period just over or just under the line, and read whether the stock is preference stock with dividends attributable to more than 366 days — that is the only circumstance in which the 90-day rule applies.

Watch for a self-created work. The character turns on § 1221(a)(3), and only music has an election.

Check yourself

1. A single taxpayer has a 9,000-dollar net capital loss and no capital gains. How much reduces ordinary income this year, and what happens to the rest?

Answer: 3,000 dollars, under IRC § 1211(b)(1). The remaining 6,000 dollars carries to the succeeding year under § 1212(b)(1), keeping its short-term or long-term character, with no expiry.

2. Shares are bought on 12 June 2025. What is the first date a sale produces long-term gain?

Answer: 13 June 2026. IRC § 1222(3) requires the asset to be held more than one year, so the day after the anniversary is the first qualifying date.

3. A taxpayer sells stock at a loss on 10 March and buys the same stock on 2 April. What is the consequence?

Answer: The loss is disallowed by IRC § 1091(a), the purchase being within 30 days after the sale, and under § 1091(d) the basis of the replacement shares is increased by the disallowed loss, deferring it to the later disposition.

4. A shareholder held mutual fund shares for four months and receives a capital gain distribution. Is it short-term?

Answer: No. IRC § 852(b)(3)(B) requires the shareholder to treat a capital gain dividend as gain from a capital asset held more than one year, regardless of how long the shares themselves were held.

5. A painter sells a canvas she created. Can she elect capital asset treatment as a composer could?

Answer: No. IRC § 1221(a)(3)(A) excludes an artistic composition held by its creator, and the election in § 1221(b)(3) reaches only musical compositions and copyrights in musical works. Her gain is ordinary.