Capital Gain &
Loss Rules

Master the tax treatment of capital assets: holding periods, netting procedures, and the $\$3{,}000$ loss limitation for the CPA REG exam.

CPA Regulation (REG)

What Is a Capital Asset?

Under IRC §1221, a capital asset is any property held by a taxpayer except for certain exclusions. The simplest way to remember it: everything is a capital asset unless specifically excluded.

✓ Capital Assets

Stocks, bonds, personal-use property (home, car), investment real estate, collectibles

✕ Not Capital Assets

Inventory, accounts receivable, depreciable business property, supplies, self-created copyrights

Short-Term vs. Long-Term

The holding period determines whether a gain or loss is short-term or long-term. The dividing line is simple: more than one year (366+ days) qualifies as long-term.

Computing Gain or Loss

The fundamental formula for any capital transaction is straightforward:

Amount Realized

Cash received + FMV of property received + liabilities assumed by buyer - selling expenses

Adjusted Basis

Original cost + capital improvements - depreciation - casualty loss deductions

The Netting Process

Capital gains and losses must be netted within their holding period groups before crossing over. This is the required order:

1

Net within each group: Short-term gains offset short-term losses. Long-term gains offset long-term losses.

2

Cross-net if needed: A net short-term loss offsets net long-term gain (and vice versa).

3

Apply the result: Net capital gain is taxed at the applicable rate. Net capital loss is deductible up to $\$3{,}000$ per year.

Netting Flowchart

The $\$3{,}000$ Loss Limitation

After netting, if you have a net capital loss, the deduction against ordinary income is capped at $\$3{,}000$ per year ($\$1{,}500$ if married filing separately). Any excess carries forward indefinitely.

Annual Limit

$\$3{,}000$ for single, MFJ, HoH. $\$1{,}500$ for MFS.

Carryforward

Excess losses carry forward to future years and retain their character (ST or LT).

Use Order

Short-term carryforward losses are used first, then long-term carryforward losses.

Tax Rate Comparison

	Short-Term	Long-Term
Holding Period	$ \le 1 $ year	$ > 1 $ year
Tax Rate	10% - 37% (ordinary)	0%, 15%, or 20%
Net Investment Income Tax	+3.8% if AGI exceeds threshold	+3.8% if AGI exceeds threshold
Collectibles (art, coins)	Ordinary rates	Max 28%
Unrecaptured §1250 Gain	Ordinary rates	Max 25%

Special Holding Period Rules

1

Inherited property: Always treated as long-term, regardless of how long the decedent or heir held it.

2

Gifted property (gain scenario): Donor's holding period "tacks on" to the donee's period.

3

Gifted property (loss scenario using FMV basis): Holding period starts on the date of the gift: no tacking.

4

Wash sales: Holding period of the disallowed loss shares tacks onto the replacement shares.

How to Apply the Rules

1

Classify the asset: Is it a capital asset under §1221? If excluded, it receives ordinary or §1231 treatment.

2

Determine holding period: Count from the day after acquisition to the date of sale. $ > 1 $ year = long-term.

3

Calculate gain or loss: $\text{Amount Realized} - \text{Adjusted Basis}$.

4

Net within groups: STCG vs. STCL, then LTCG vs. LTCL.

5

Cross-net: Net ST result against net LT result.

6

Apply limits: If net loss, deduct up to $\$3{,}000$. Carry forward the rest.

Example 1: Basic Netting

A taxpayer has the following transactions in 2024:

STCG

$\$5{,}000$

STCL

$(\$2{,}000)$

LTCG

$\$8{,}000$

LTCL

$(\$10{,}000)$

Example 2: Loss Limitation

Same taxpayer, different numbers:

STCG

$\$1{,}000$

STCL

$(\$4{,}000)$

LTCG

$\$2{,}000$

LTCL

$(\$6{,}000)$

Example 3: Inherited Stock

Tom inherits stock from his mother on March 1, 2024. His mother bought the stock 6 months ago for $\$20{,}000$. The FMV on the date of death is $\$35{,}000$. Tom sells it on April 15, 2024 for $\$38{,}000$.

1

Basis: Stepped-up to FMV at death = $\$35{,}000$

2

Gain: $\$38{,}000 - \$35{,}000 = $ $\$3{,}000$

3

Character: Even though Tom only held the stock 45 days, inherited property is always long-term.

The Wash Sale Rule

Under IRC §1091, a loss is disallowed if you purchase substantially identical securities within 30 days before or after the sale.

Common Mistakes

✕ Forgetting the Netting Order

You must net within ST and LT groups first, then cross-net. Skipping the first step gives the wrong character.

✕ Wrong Limit for MFS

Married Filing Separately filers are limited to $\$1{,}500$, not $\$3{,}000$. This is frequently tested.

✕ Inherited = Short-Term

Students often classify inherited property based on the heir's actual holding period. Inherited property is always long-term.

Summary Comparison

Rule	Short-Term	Long-Term
Holding Period	$ \le 1 $ year	$ > 1 $ year
Tax Rate	Ordinary rates (up to 37%)	0%, 15%, or 20%
Loss Deduction Limit	$\$3{,}000$ combined ($\$1{,}500$ MFS)
Loss Carryforward	Indefinite; retains ST/LT character
Inherited Property	Always long-term; stepped-up basis
Wash Sale	Loss disallowed; added to replacement basis

Question 1 of 5

A single taxpayer has $\$8{,}000$ STCG, $\$3{,}000$ STCL, $\$2{,}000$ LTCG, and $\$12{,}000$ LTCL. What is the net capital loss deductible against ordinary income?

Net ST: $\$8{,}000 - \$3{,}000 = \$5{,}000$ STCG. Net LT: $\$2{,}000 - \$12{,}000 = (\$10{,}000)$ LTCL. Cross-net: $\$5{,}000 - \$10{,}000 = (\$5{,}000)$. The deductible amount is capped at $\$3{,}000$, with $\$2{,}000$ carried forward.

Question 2 of 5

Sarah inherits stock on June 1, 2024 and sells it on July 15, 2024. Her mother had purchased the stock 4 months earlier. How is the gain classified?

Inherited property is automatically treated as long-term, regardless of how long the decedent or the heir actually held it. This is a specific statutory rule in IRC §1223(9).

Question 3 of 5

Mark sells stock at a $\$10{,}000$ loss and buys substantially identical stock 25 days later. What is the tax effect?

Because the repurchase occurred within 30 days of the sale, the wash sale rule applies. The $\$10{,}000$ loss is disallowed but added to the basis of the new shares. It is deferred, not permanently lost.

Question 4 of 5

A married couple filing separately has a net capital loss of $\$6{,}000$. How much can they deduct against ordinary income?

For Married Filing Separately (MFS) taxpayers, the capital loss deduction limit is $\$1{,}500$ per year, not $\$3{,}000$. The remaining $\$4{,}500$ carries forward to future years.

Question 5 of 5

Which of the following is NOT a capital asset?

Under IRC §1221, inventory held for sale to customers in the ordinary course of business is specifically excluded from the definition of a capital asset. All other options are capital assets.

	Short-Term	Long-Term
Holding Period	\( \le 1 \) year	\( > 1 \) year
Tax Rate	10% - 37% (ordinary)	0%, 15%, or 20%
Net Investment Income Tax	+3.8% if AGI exceeds threshold	+3.8% if AGI exceeds threshold
Collectibles (art, coins)	Ordinary rates	Max 28%
Unrecaptured §1250 Gain	Ordinary rates	Max 25%

Capital Gain &Loss Rules

What Is a Capital Asset?

Short-Term vs. Long-Term

Computing Gain or Loss

The Netting Process

Netting Flowchart

The \(\$3{,}000\) Loss Limitation

Tax Rate Comparison

Special Holding Period Rules

How to Apply the Rules

Example 1: Basic Netting

Example 2: Loss Limitation

Example 3: Inherited Stock

The Wash Sale Rule

Common Mistakes

Summary Comparison

Question 1 of 5

Question 2 of 5

Question 3 of 5

Question 4 of 5

Question 5 of 5

Capital Gain &
Loss Rules