5.2 How Property Sales Are Classified and Taxed

The tax treatment of gains and losses is not the same for all types of property sales. Tax reporting generally depends on your purpose in holding the property, as shown in Table 5-1.

Filing Tip

Holding Periods

The time you own a capital asset determines short-term or long-term treatment. The short-term holding period is a year or less, the long-term period more than one year (5.9–5.12).

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When capital gain or loss treatment does not apply.

Certain sales do not qualify for capital gain or loss treatment. Business inventory and property held for sale to customers are not capital assets. Depreciable business and rental property are not capital assets, but you may still realize capital gain after following a netting computation for Section 1231 assets (44.8).

Although assets held for personal use, such as a car or home, are technically capital assets, you may not deduct a capital loss on their sale.

Certain other assets held for investment or personal use are excluded by law from the capital asset category. These include copyrights, literary or musical compositions, letters, memoranda, or similar property that: (1) you created by your personal efforts or (2) you acquired as a gift from the person who created the property or for whom the property was prepared or produced.

Although musical compositions and copyrights in musical works that you personally created (or you acquired as a gift from the creator) are generally excluded from the capital asset category, you can make an election on a timely filed (including extensions) Schedule D for the year the musical composition or copyright is sold to treat the sale as a sale of a capital asset.

Also excluded from the capital asset category are letters, memoranda, or similar property prepared or produced for you by someone else. Finally, U.S. government publications obtained from the government for free or for less than the normal sales price do not qualify as capital assets.

Stock is generally treated as a capital asset, but losses on Section 1244 stock of qualifying small businesses may be claimed as ordinary losses on Form 4797, rather than on Schedule D as capital losses subject to the $3,000 deduction limit ($1,500 if married filing separately) (30.13).

Traders in securities may elect to report their sales as ordinary income or loss rather than as capital gain or loss (30.16).

Small business stock deferral.

Taxable gains from the sale of publicly traded securities may be postponed if you roll over the proceeds to stock or a partnership interest in a SSBIC (specialized small business investment company) (5.7).

Small business/empowerment zone business stock exclusion.

Gains on the 2012 sale of qualifying small business stock held for more than five years qualify for a 50% exclusion.

Like-kind exchanges of business or investment property.

Exchanges of like-kind business or investment property are subject to special rules that allow gain to be deferred, generally until you sell the property received in the exchange (6.1). When property received in a tax-free exchange is held until death, the unrecognized gain escapes income tax forever because the basis of property in the hands of an heir is generally the fair market value of the property at the date of death (5.17). A loss on a like-kind exchange is not deductible.

Stock redemption allocation to covenant not to compete.

If you sell company stock back to your employer and you are subject to a covenant not to compete with the company for a period of time, any portion of the purchase price for the stock that is allocated to the covenant in the contract is taxed to you as ordinary income and not capital gain.