Capital Gains and Losses

Understanding capital gains taxation is essential for tax planning and wealth management. This section covers what qualifies as a capital asset, holding period requirements, tax rates, netting rules, and special provisions that CFP candidates must master.

---

What Is a Capital Asset?

A capital asset includes most property owned by a taxpayer, whether for personal use or investment. However, the tax code specifically excludes certain items.

Capital Assets INCLUDE:

• Stocks, bonds, and mutual funds
• Personal residence and vacation homes
• Personal-use property (cars, jewelry, furniture)
• Investment real estate (not used in trade or business)
• Collectibles (art, coins, antiques, precious metals)

Capital Assets DO NOT Include:

• Inventory - Property held for sale to customers
• Accounts and notes receivable - Arising from business operations
• Depreciable business property - Section 1231 assets (equipment, machinery)
• Real property used in trade or business - Section 1231 assets
• Copyrights and creative works - When held by the creator
• Supplies - Consumed in business operations

Exam Tip: The distinction matters because capital assets receive preferential tax treatment on gains, while Section 1231 and ordinary income assets have different rules for gains and losses.

---

Holding Period: Short-Term vs. Long-Term

The holding period determines whether a gain or loss is classified as short-term or long-term.

The "One Year Plus One Day" Rule

To qualify for long-term treatment, you must hold the asset for more than one year. Think of it as "one year plus one day."

Example: If you purchase stock on January 15, 2025, you must hold it until at least January 16, 2026, for long-term treatment. Selling on January 15, 2026, would be short-term.

Special Holding Period Rules

---

2025 Long-Term Capital Gains Tax Rates

Long-term capital gains are taxed at preferential rates based on taxable income and filing status.

2025 LTCG Rate Thresholds

Important: These thresholds are based on taxable income, not AGI. Add your capital gains to your ordinary income to determine which bracket applies.

Special Capital Gains Rates

Net Investment Income Tax (NIIT)

High-income taxpayers may owe an additional 3.8% NIIT on the lesser of:

• Net investment income, OR
• MAGI exceeding $200,000 (single) / $250,000 (MFJ)

This can bring the maximum federal rate on long-term gains to 23.8% (20% + 3.8% NIIT).

---

Capital Gains and Losses Netting Rules

When you have multiple capital transactions, you must net gains and losses following a specific process.

Step-by-Step Netting Process

1. Net within each category first:

   • Long-term gains against long-term losses = Net LTCG or LTCL
   • Short-term gains against short-term losses = Net STCG or STCL

2. Then net across categories (if different signs):

   • Net LTCG against Net STCL, OR
   • Net LTCL against Net STCG

3. Apply capital loss limitations (see below)

Netting Example

Step 1: Net within categories

• LTCG: $10,000 - $3,000 = $7,000 Net LTCG
• STCG: $5,000 - $6,000 = ($1,000) Net STCL

Step 2: Net across categories

• $7,000 LTCG - $1,000 STCL = $6,000 Net LTCG (taxed at preferential rates)

---

Capital Loss Deduction Limit

If capital losses exceed capital gains, the excess is deductible against ordinary income—but with an annual limit.

Personal-Use Property Losses

Losses on personal-use property are NOT deductible. If you sell your personal car or furniture at a loss, you cannot claim that loss.

• Personal-use gains: Taxable as capital gains
• Personal-use losses: Not deductible (disallowed)

---

Wash Sale Rule

The wash sale rule prevents taxpayers from claiming a loss while maintaining essentially the same investment position.

What Triggers a Wash Sale?

A wash sale occurs when you sell securities at a loss AND acquire substantially identical securities within the 61-day window:

• 30 days BEFORE the sale, OR
• 30 days AFTER the sale

Wash Sale Consequences

Wash Sale Example

Sean bought Hot Stock for $80/share. The price fell to $5, and he sold on December 18 to recognize a $75/share loss. On January 5, he bought the stock back at $18/share.

Result:

• Loss of $75/share is disallowed due to wash sale
• New basis = $18 + $75 = $93/share
• If Sean later sells at $93 or more, he recovers the previously disallowed loss

Exam Tip: The wash sale rule applies ONLY to losses, not gains. It also does not apply to gains—you can sell at a gain and immediately repurchase.

---

Section 121: Primary Residence Exclusion

Section 121 provides a significant tax benefit for homeowners selling their primary residence.

Exclusion Amounts

Qualification Requirements

To claim the full exclusion, you must meet:

1. Ownership Test: Owned the home for at least 2 of the last 5 years
2. Use Test: Used the home as your principal residence for at least 2 of the last 5 years
3. Frequency Test: Have not used the exclusion within the prior 2 years

For MFJ to claim the full $500,000:

• Either spouse meets the ownership requirement
• BOTH spouses meet the use requirement

Reduced Exclusion

If you don't meet the full requirements due to:

• Change in employment
• Health reasons
• Unforeseen circumstances (divorce, death, natural disaster, etc.)

Reduced Exclusion Formula:

(Months of Qualified Use / 24) x Maximum Exclusion = Reduced Exclusion

Non-Qualified Use (Post-2008)

Beginning in 2009, gain attributable to non-qualified use periods (such as rental use) is not eligible for the Section 121 exclusion.

Non-Qualified Use Calculation:

(Non-Qualified Use Period / Total Ownership Period) x Total Gain = Taxable Portion

---

Worthless Securities

When securities become completely worthless, they receive special treatment.

Practical Implication: Even if stock became worthless in February, the "sale date" is December 31, which may convert a short-term loss into a long-term loss.

---

Key Exam Points Summary