5.3 Capital Gains Rates and Holding Periods
Form 8949 is used for reporting sales of capital assets. On Form 8949, you separate your 2012 sales into short-term and long-term categories. Assets held for one year or less are in the short-term category and assets held for more than one year are in the long-term category. The totals from Form 8949 are entered on Schedule D (Form 1040).
The computation of tax liability using the favorable long-term capital gain rates is not made directly on Schedule D, but on worksheets in the IRS instructions. Mutual-fund and REIT investors may be able to apply the favorable rates on the “Qualified Dividends and Capital Gain Tax Worksheet” included in the Form 1040 or Form 1040A instructions, without having to file Form 8949 or Schedule D (32.8).
See the Example in 5.8, which includes filled-in samples of Form 8949 and Schedule D, and a Qualified Dividends and Capital Gain Tax Worksheet.
Held for a year or less.
Details for sales of capital assets held for a year or less are reported in Part I of Form 8949. The total sales prices and total cost basis for all the short-term transactions, along with any adjustments for such transactions, are transferred to Part I of Schedule D, where the net short-term gain or loss for the year is determined. A net short-term capital gain is subject to regular tax rates. A net short-term loss offsets a net long-term gain, if any, from Part II of Schedule D. A net short-term loss in excess of net long-term gain is deductible up to the $3,000 capital loss limit (5.4).
Held for more than a year.
Details for sales of capital assets held for more than a year are reported in Part II of Form 8949. The total sales prices and total cost basis for all the long-term transactions, along with any adjustments for such transactions, are transferred to Part II of Schedule D, where the net long-term gain or loss for the year is determined. A net long-term capital loss offsets a net short-term gain, if any, from Part I of Schedule D. If you have a net long-term capital gain and also a net short-term capital loss from Part I of Schedule D, the short-term loss offsets the net long-term gain. If the net short-term loss exceeds the net long-term gain, the excess short-term loss is deductible up to the $3,000 capital loss limit (5.4). If you have a net long-term gain in excess of a net short-term capital loss (if any), the excess is called net capital gain and it is this amount to which the favorable capital gain rates may apply, as discussed below.
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Reduced Rates on Net Capital Gain for 2012
Tax liability must be computed on IRS worksheets to benefit from capital gain rates. Net capital gain (net long-term capital gain in excess of net short-term capital loss) is subject to maximum tax rates that are generally lower than the rates applied to ordinary income. Qualified dividends (4.1) for 2012 are subject to the same favorable rates as net capital gain.
If you have a net capital gain that does not include a 28% rate gain or unrecaptured Section 1250 gain (see below), you should compute your 2012 regular tax liability on the “Qualified Dividends and Capital Gain Tax Worksheet” in the IRS instructions for Line 44 of Form 1040. On the Worksheet, you figure your regular tax liability for 2012, taking into account the favorable capital gain rates, as applicable, and the regular tax rates on the rest of your taxable income. The Worksheet must be used instead of the regular IRS Tax Table or Tax Computation Worksheet to benefit from the maximum capital gain rates. The tax liability from the Worksheet is entered on Line 44 of Form 1040.
If you have a net capital gain that includes either a net 28% rate gain or unrecaptured Section 1250 gain, you must compute your tax liability on the “Schedule D Tax Worksheet” in the Schedule D instructions to benefit from the maximum capital gain rates. The tax liability from the Worksheet is entered on Line 44 of Form 1040.
On both the Qualified Dividends and Capital Gain Tax Worksheet and the Schedule D Tax Worksheet, net capital gain eligible for the maximum capital gain rates is reduced by any gains that you elect to treat as investment income on Form 4952 to increase your itemized deduction for investment interest (15.10).
The 0% and 15% rates.
Qualified dividends (4.1) and net capital gain (net long-term gains in excess of short-term losses) for 2012 are generally subject to the 0% or 15% capital gain rate. However, the 0% and 15% rates do not apply to any portion of net capital gain that is 28% rate gain (from collectibles and Section 1202 exclusion) or unrecaptured Section 1250 gain; these are subject, respectively, to maximum rates of 28% and 25% as discussed below.
You qualify for the 0% rate if your top tax bracket is 10% or 15%.
This means that if your 2012 taxable income is within the 10% and 15% brackets, and all of your net capital gain is eligible for the 0%/15% rates (gains are not 28% rate gains or unrecaptured Section 1250 gains), then all of your 2012 gains and qualified dividends are tax free under the 0% rate. On 2012 returns, the top of the 15% bracket is taxable income of $35,350 for single taxpayers and married persons filing separately, $47,350 for heads of household, and $70,700 for married persons filing jointly. Thus, if your 2012 taxable income is no more than the applicable amount for your filing status, none of your 2012 qualified dividends or gains are taxable.
Perhaps surprisingly, individuals with a top bracket higher than 15% may also be able to benefit from the 0% rate. The extent to which higher-bracket taxpayers can benefit from the 0% rate depends on their taxable income, their filing status, which determines the top of their 15% bracket, and the amount of their qualified dividends and net capital gain. On the IRS worksheets used to figure tax liability (the “Qualified Dividends and Capital Gain Tax Worksheet,” or the “Schedule D Tax Worksheet,” as applicable), your taxable income is reduced by your qualified dividends and net capital gain (other than 28% rate gain and unrecaptured Section 1250 gain). The resulting amount is treated as ordinary income and if it is less than the top of your 15% bracket, your qualified dividends and capital gains (other than 28% rate gain and unrecaptured Section 1250 gain) are tax free under the 0% rate to the extent that they “fill up” the rest of the 15% bracket. For example, if you are single and for 2012 you have taxable income of $46,000, including $2,000 of qualified dividends and $12,000 of eligible net capital gain, your ordinary income for purposes of the worksheet computation is $32,000 ($46,000− $14,000), and since the top of the 15% bracket for single taxpayers is taxable income of $35,350, there is still $3,350 left within the 15% bracket ($35,350-$32,000). The 0% rate applies to $3,350 of your gains/dividends and the $10,650 balance ($14,000− $3,350) is taxed at 15%. Also see Example 2 below for how a married couple filing jointly with a top bracket exceeding 15% can benefit from the 0% rate.
If the ordinary income is equal to or more than the top of your 15% bracket ($35,350, $47,350, or $70,700, as applicable), the 0% rate will not apply to any of your qualified dividends and eligible gains. The Examples below further illustrate the application of the 0% and 15% rates. Also see the Example in 5.8, which includes a filled-in Schedule D and Qualified Dividends and Capital Gain Tax Worksheet.
Caution: Children subject to the kiddie tax.
If your child is subject to the kiddie tax (24.2) and has net investment income exceeding $1,900 for 2012, the excess is treated as your own income and subject to your tax rate. If the excess includes net capital gains and qualified dividends, your maximum capital gain rate will apply if it is higher than your child’s rate. Even if the 0% rate would apply to your child’s 2012 gains and dividends based on his or her taxable income, the 0% rate will not be available unless your rate is also 0% when you make the kiddie tax computation on Form 8615.
28% rate gains from sales of collectibles and small business or empowerment zone business stock eligible for exclusion.
Long-term gains on the sale of collectibles such as art, antiques, precious metals, gems, stamps, and coins are considered “28% rate gains.” If you sell qualified small business stock eligible for the 50% exclusion (Section 1202 exclusion (5.7)), the taxable 50% portion of the gain is also treated as a 28% rate gain. The 28% rate transactions are reported first in Part II (long-term capital gains and losses) of Form 8949 and then transferred to Schedule D. If taking into account all your transactions you have both a net long-term capital gain for the year and a net capital gain (excess of net long-term gain over net short-term loss if there is one), you have to complete the “28% Rate Gain Worksheet” in the Schedule D instructions. On the Worksheet, 28% rate gains are reduced by any long-term collectibles losses and net short-term capital loss for the current year, and any long-term capital loss carryover from the previous year.
A net 28% rate gain from the 28% Rate Gain Worksheet is entered on Line 18 of Schedule D and then on the “Schedule D Tax Worksheet” in the Schedule D instructions. The Schedule D Tax Worksheet is used to figure the regular tax on all of your taxable income (not just on your net capital gain and qualified dividends). The effect of the worksheet computation is to tax 28% rate gain at either the 28% rate or at the regular rates on ordinary income, whichever results in the lower tax.
The tax figured on the “Schedule D Tax Worksheet” is entered on Line 44 of Form 1040.
Unrecaptured Section 1250 gain on sale of real estate.
Long-term gain in 2012 that is attributable to real estate depreciation is not eligible for the 0% or 15% capital gain rate. Gain attributable to pre-1987 depreciation may be recaptured as ordinary income (44.2). To the extent of depreciation that is not recaptured, gain is considered “unrecaptured Section 1250 gain.” Unrecaptured Section 1250 gain is figured on the “Unrecaptured Section 1250 Gain Worksheet” in the Schedule D instructions. The computation reduces unrecaptured Section 1250 gain by a net loss, if any, from the 28% rate group.
The net unrecaptured Section 1250 gain from the worksheet is entered on Line 19 of Schedule D and then on the Schedule D Tax Worksheet, where tax liability on all of your taxable income is computed. The effect of the computation on the Schedule D Tax Worksheet is to tax unrecaptured Section 1250 gain at either a 25% rate or at the regular rates on ordinary income, whichever results in the lower tax. The tax figured on the Schedule D Tax Worksheet is entered on Line 44 of Form 1040.
Capital gain distributions from mutual funds.
Your fund will report long-term capital gain distributions on Form 1099-DIV. See Chapter 32 for details on how to report the distributions.
Capital gain from Schedule K-1.
Net capital gain or loss from a pass-through entity such as a partnership, S corporation, estate, or trust is reported to you on a Schedule K-1. Report net short-term gain or loss in Part I of Schedule D and net long-term gain or loss in Part II of Schedule D.