To figure the basis of property you get as a gift, you must know its adjusted basis to the donor just before it was given to you. You also must know its fair market value (FMV) at the time it was given to you. and whether any gift tax was paid. If the FMV of the property at the time of the gift is less than the donor's adjusted basis, your basis depends on whether you have a gain or loss when you dispose of the property. Your basis for figuring gain is the same as the donor's adjusted basis, plus or minus any required adjustments to basis while you held the property. Your basis for figuring a loss is the FMV of the property when you received the gift, plus or minus any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.

If you use the donor's adjusted basis for figuring a gain and get a loss, and then use the FMV for figuring a loss and get a gain, you have neither a gain nor loss on the sale or disposition of the property.

If the FMV is equal to or greater than the donor's adjusted basis, your basis is the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift. See Gifts received before 1977 in Publication 551, Basis of Assets. Also, for figuring gain or loss, you must increase or decrease your basis by any required adjustments to basis while you held the property. See Adjusted Basis in Publication 551, Basis of Assets.

For more information on the gift tax, see Publication 950, Introduction to Estate and Gift Taxes..

References:

• Publication 551, Basis of Assets
• Publication 950, Introduction to Estate and Taxes

Basis is your investment in property for tax purposes. The difference between the selling price of your assets and your basis determines whether there is a taxable gain or loss on the disposition of your property. You need to determine your basis to figure allowable depreciation deductions as well. Your original basis is usually your cost to acquire the asset. Your adjusted basis (which is the basis you use to determine gain or loss or depreciation amounts) is the result of increasing or decreasing your original basis according to certain events.

Increases to basis include but are not limited to:

. Improvements having a useful life of more than a year

. Assessments for local improvements

. Sales tax

. The cost of extending utilities lines to the property

. Legal fees such as the cost of defending or perfecting title

. Zoning costs

Decreases to basis include but are not limited to:

. Depreciation

. Nontaxable corporate distributions

. Casualty and theft losses

. Easements

. Rebates from the manufacturer or seller

Additional information on basis can be found in Publication 551, Basis of Assets, or Tax Topic 703, Basis of Assets.

References:

• Publication 551, Basis of Assets
• Tax Topic 703, Basis of Assets

Report the sale of your main home on your tax return only if you have a gain and at least part of it is taxable, or you have a gain and choose not to exclude it. Report any taxable gain on Form 1040, Schedule D (PDF), Capital Gains and Losses. Form 2119, Sale of Your Home is obsolete beginning in 1998. For more information, refer to Publication 523, Selling Your Home.

References:

• Publication 523, Selling Your Home
• Form 1040, Schedule D (PDF), Capital Gains and Losses

If you meet the ownership and use tests, you will generally only need to report the sale of your home if your gain exceeds a certain dollar amount prescribed by law. To determine the amount of gain that can be excluded from income refer to Publication 523, Selling Your Home. You may be entitled to exclude gain from income if during the 5-year period ending on the date of the sale, you have:

• Owned the home for at least 2 years (the ownership test), and
• Lived in the home as your main home for at least 2 years (the use test).

If you were on qualified extended duty in the U.S. Armed Services or the Foreign Service you may suspend the five-year test period for up to 10 years. You are on qualified extended duty when the extended duty lasts for more than 90 days or for an indefinite period AND:

• At a duty station that is at least 50 miles from the residence sold, or
• When residing under orders in government housing.

This change applies to home sales after May 6, 1997. You may use this provision for only one property at a time and one sale every two years.

References:

• Publication 523, Selling Your Home
• Tax Topic 701, Sale of your Home - after May 6, 1997
• Tax Topic 703, Basis of Assets

It is not the money you receive for the sale of your home, but the amount of gain on the sale over your cost, or basis, that determines whether you will have to include any proceeds as taxable income on your return. You may be able to exclude this gain from income up to a maximum dollar limit. If you can exclude all of the gain, you do not need to report the sale on your tax return. To determine the maximum dollar limit you can exclude or for additional information on selling your home, refer to Publication 523, Selling Your Home.

References:

• Publication 523, Selling Your Home
• Tax Topic 701, Sale of your Home - after May 6, 1997
• Tax Topic 703, Basis of Assets

You cannot exclude gain on the sale of your home if, during the 2-year period ending on the date of the sale, you sold another home at a gain and excluded all or part of that gain. If you cannot exclude the gain, you must include it in your income.

Exception. You still can claim an exclusion, but the maximum amount of gain you can exclude will be reduced, if the reason you sold the home was:

• A change in place of employment
• Health, or
• Unforeseen circumstances (as defined earlier)

With the exception of the 2-year waiting period, there is no limit on the number of times you can exclude the gain on the sale of your principle residence so long as you meet the ownership and use tests.

References:

• Publication 523, Selling Your Home
• Tax Topic 701, Sale of Your Home - after May 6, 1997
• Tax Topic 703, Basis of Assets

If you owned and lived in the property as your main home for less than 2 years, you may still be able to claim an exclusion in some cases.

You can claim this reduced exclusion if either of the following is true.

(1) You did not meet the ownership and use tests on a home you sold due to:

. health reasons

. a change in place of employment, or

. unforeseen circumstances. (see below)

(2) Your exclusion would have been disallowed because of the rule on selling more than one home in a two year period, except you sold the home due to:

. health reasons

. a change in place of employment, or

. unforeseen circumstances. (see below)

Use the worksheet in Publication 523, Selling Your Home, to figure your reduced exclusion.

The IRS has issued regulations describing whether you may qualify for a reduced maximum exclusion. See Treasury Regulation 1.121-3 and Publication 523, Selling Your Home.

References:

• Publication 523, Selling Your Home
• Tax Topic 701, Sale of Your Home - after May 6, 1997

If, during the 5-year period ending on the date of sale, you owned the home for at least 2 years and lived in it as your main home for at least 2 years, you can exclude up to the maximum dollar limit. However, you cannot exclude the portion of the gain equal to depreciation allowed or allowable for periods after May 6, 1997. This gain is reported on Form 4797 (PDF),Sale of Business Property. Refer to Publication 523, Selling Your Home, and Form 4797 (PDF), Sale of Business Property, for specifics on calculating and reporting the amount of gain.

References:

• Publication 523, Selling Your Home
• Publication 527, Residential Rental Property
• Form 4797 (PDF), Sale of Business Property

Your second home is considered a capital asset. Use Form 1040, Schedule D (PDF)to report sales, exchanges, and other dispositions of capital assets. If you have a qualified home office or rent your second home, see Publication 587, Business Use of Your Home, or Publication 527Residential Rental Property for more details on reporting the sale of your second residence.

References:

• Publication 527, Residential Rental Property
• Publication 544,Sales and Other Dispositions of Assets
• Publication 587, Business Use of Your Home
• Tax Topic 703, Basis of Assets
• Tax Topic 409, Capital Gains and Losses

To figure the basis of property you receive as a gift, you must know its adjusted basis to the donor just before it was given to you, its fair market value (FMV) at the time it was given to you, and the amount of any gift tax paid on it.

If the FMV of the property was less than the donor's adjusted basis, your basis for figuring gain on its sale or other disposition is the same as the donor's adjusted basis plus or minus any required adjustment to basis during the period you held the property. Your basis for figuring loss on its sale or other disposition is its FMV at the time you received the gift plus or minus any required adjustment to basis during the period you held the property.

If the FMV of the property was equal to or greater than the donor's adjusted basis, your basis for figuring gain or loss on its sale or other disposition is the same as the donor's adjusted basis at the time you received the gift. Increase your basis by all or part of any gift tax paid, depending on the date of the gift.

For further information, refer to Publication 17, Chapter 14, Basis of Property.

For additional information on this subject see Gifts.

References:

• Publication 17, Your Federal Income Tax

When you trade stock in one corporation for stock in another as part of a merger or other qualifying reorganization, you may have a nontaxable exchange. The basis of the stock you received is generally the same as the basis of the old stock, increased by any gain recognized on the exchange (including gain that is treated as a dividend) and decreased by the value of property or money received.

You may receive cash or something of value instead of a fractional share if the number of shares of new stock doesn't divide evenly into the number of shares of the old stock. You treat this as a sale of the fractional share.

Your basis in the new stock is determined, in whole or in part, by your basis in the old stock. Your holding period for the new stock will include the holding period for the old stock, provided that the old stock was held as a capital asset at the time of the exchange. For special basis rules relating to incentive stock options and options granted under employee stock purchase plan see Revenue Ruling 80-244, in IRS 1980-2 Cumulative Bulletin at page 235.

Refer to Publication 550, Investment Income and Expenses.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

When the old stock and the new stock are identical the basis of the old shares must be allocated to the old and new shares. Thus, you generally divide the adjusted basis of the old stock by the number of shares of old and new stock. The result is your new basis per share of stock. If the old shares were purchased in separate lots for differing amounts of money, the adjusted basis of the old stock must be allocated between the old and new stock on a lot by lot basis.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital Gains and Losses

Usually, the company issuing the new type of stock will send you a letter explaining the tax consequences of the stock distribution, including how to calculate the basis in the two different types of stock.

If you did not get such a letter or would like further assistance, call IRS customer service at 1-800-829-1040 or refer to Publication 550, Investment Income and Expense: Stock dividends under Basis of Investment Property.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

You need to determine what your basis is in the company stock on the date of the split. The new shares assume part of your basis in the company stock on that date. You must divide the adjusted basis in the old stock by the number of shares of old and new stock. The result is your basis for each share of stock.

For example, if you owned two shares of company stock with a basis in one at $30 and the other $45, and the company declares a three for one stock split, you now have six shares of stock. Three of the shares will have a basis of $10, and three will have a basis of $15.

Because this is an employee stock purchase plan, you may have to report some or all of the gain on the sale of this stock as ordinary income (wages). For more information about employee stock purchase plans, see Publication 525, Taxable and Nontaxable Income.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses
• Publication 525, Taxable and Nontaxable Income

Ordinarily, you do not have to report the purchase of stock..

However, if you exercise a nonstatutory stock option, a type of stock option generally granted by an employer, you may have income to report in the year of exercise (the excess of the fair market value of the stock at the time of exercise less the exercise price) if your rights in the stock are substantially vested at the time of exercise, see Publication 525, Taxable and Nontaxable Income, for further information.

References:

• Publication 550, Investment Income and Expenses
• Publication 525, Taxable and Nontaxable Income
• Tax Topic 409, Capital gains and losses

The basis of stocks or bonds you own generally is the purchase price plus the costs of purchase, such as commissions and recording or transfer fees. If you acquired stock or bonds other than by purchase, your basis is usually determined by fair market value or the previous owner's adjusted basis.

The basis of stock must be adjusted for certain events that occur after purchase. For example, if you receive more stock from nontaxable stock dividends or stock splits, you must reduce the basis of your original stock. You must also reduce your basis when you receive nontaxable distributions, because these are a return of capital.

The taxpayer has the burden of proving the basis of property. Failure to prove cost results in a basis, if any, determined by the IRS.

Except for certain mutual fund shares, you cannot use an average price per share to figure the gain or loss on the sale of stock.

Refer to Stocks and Bonds under Basis of Investment Property in Chapter 4 of Publication 550, Investment Income and Expenses .

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses
• Publication 552, Recordkeeping for Individuals

If you can identify which shares of stock you sold, your basis is what you paid for the shares sold (plus sales commissions). If you sell a block of the same kind of stock, you can report all the shares sold at the same time as one sale, writing VARIOUS in the "date acquired" column of Form 1040, Schedule D (PDF). However, what you enter into the "cost or other basis" column is the total of all the acquisition costs of the shares sold.

If you cannot adequately identify the shares you sold and you bought the shares at various times for different prices, the basis of the stock sold is the basis of the shares you acquired first (first-in first-out). Except for certain mutual fund shares, you cannot use the average price per share to figure gain or loss on the sale of stock.

For more information, refer to Publication 550, Investment Income and Expenses.

References:

• Publication 525, Taxable and Nontaxable Income
• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital Gains and Losses
• Form 1040, Schedule D (PDF)

No, the average basis method may be used only for mutual fund shares that were purchased at various times for various prices if the shares are left in the custody of a custodian or agent in an account maintained for the acquisition or redemption of the shares.

References:

• Publication 550, Investment Income and Expenses
• Publication 564, Mutual Fund Distributions

Some corporations allow investors to choose to use their dividends to buy more shares of stock in the corporation instead of receiving the dividends in cash. If you are a member of this type of plan, you must report the fair market value on the dividend payment date of the dividends that are reinvested as income on your tax return. You do not actually show that the dividends were reinvested on your return. Keep records of the dollar amount of the reinvested dividends, the number of additional shares purchased, and the purchase dates. You will need this information to establish your basis when you sell the shares.

Report the dividends that were reinvested with your other dividends, if any, on Form 1040 or Form 1040A. If your total income from ordinary dividends exceeds a dollar amount set by law, you also must file either Form 1040, Schedule B (PDF) or Form 1040A, Schedule 1 (PDF).

For more information on this and other types of dividend reinvestment plans, refer to Ordinary Dividends in Chapter 1 of Publication 550, Investment Income and Expenses.

References:

• Publication 550, Investment Income and Expenses
• Form 1040, Schedule B (PDF)
• Tax Topic 404, Dividends

The basis of the stock you sold is the cost of the shares plus any adjustments, such as sales commissions. If you have not kept detailed records of your dividend reinvestments, you may be able to reconstruct those records with the help of public records from sources such as the media, your broker, or the company that issued the dividends.

If you cannot specifically identify which shares were sold, you must use the first-in first-out rule. This means that you deem that you sold the oldest shares first, then the next oldest, until you have accounted for the number of shares in the sale. In order to establish the basis of these shares, you need to have kept adequate documentation of all your purchases, including those that were made through the dividend reinvestment plan. You may not use an average cost basis. Only mutual fund shares may have an average cost basis.

Refer to Publication 550, Investment Income and Expenses, and Publication 551, Basis of Assets.

References:

• Publication 550, Investment Income and Expenses
• Publication 551, Basis of Assets
• Tax Topic 404, Dividends

Unless you sell all of your shares at one time, your total basis, which includes both your original purchase and any purchases through a dividend reinvestment, is not the figure used to report the sale of shares. If you sell less than all of your shares at one time, you need to have kept adequate documentation of all your purchases, including those that were through the dividend reinvestment plan in order to establish the basis of the shares sold. You may not use an average cost basis. Only mutual fund shares may have an average cost basis.

When reporting the sale of shares of stocks, the basis for the calculation of gain or loss is the actual cost (plus adjustments, such as sales commissions) of those shares. If you cannot specifically identify which of your shares were sold, you must use the first-in first-out rule.

For more information, refer to Publication 550, Investment Income and Expenses, and Publication 551, Basis of Assets.

References:

• Publication 550, Investment Income and Expenses
• Publication 551, Basis of Assets
• Tax Topic 404, Dividends

After you report the dividends as income, you have basis in the shares acquired through dividend reinvestment. When you report the sale of the shares, you will be taxed only on the amount that the sales proceeds (minus commissions) exceed your cost basis (in this case, the amount of the dividends reinvested).

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 404, Dividends

Yes, if they were taxable stock dividends, the holding period begins on the date the new shares were distributed by the corporation. For nontaxable stock dividends, the holding period is the same as the underlying stock.

When you purchase additional mutual shares with reinvested dividends, the dividends are generally taxable. You thus have a holding period starting on the date of the transaction, as reported in your statements, just as you do for shares that you purchase outright.

References:

• Publication 550, Investment Income and Expenses

Any shares or fractional shares purchased and sold during the current tax year are short-term capital assets. For shares purchased in the year previous to the tax year to be considered long-term, the holding period must be more than one year.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 404, Dividends

If your option is an incentive stock option, you do not include any amount in your gross income at the time the option is granted, or at the time you exercise it. However, you may have income for purposes of the alternative minimum tax in the year you exercise the option. If the special incentive stock option holding period requirements are met, any income or loss from the sale of the stock is treated as a capital gain or loss. However, if you do not meet the special holding period requirements, you may have compensation income when you sell the stock. For further information, refer to Publication 525, Taxable and Nontaxable Income, and Form 6251 (PDF), Alternative Minimum Tax-Individuals.

References:

• Publication 525, Taxable and Nontaxable Income
• Form 6251 (PDF), Alternative Minimum Tax-Individuals

Generally, if your option is a typical nonstatutory stock option, you do not include any amount in your gross income at the time the option is granted. If you receive substantially vested stock when you exercise the option, the amount to include in income at that time is the difference between the amount you pay for the stock (the option exercise price) and the fair market value of the stock measured at the time of exercise. However, if you have a nonstatutory stock option with a readily ascertainable fair market value, measured at the time of grant, different rules apply. See Publication 525, Taxable and Nontaxable Income.

References:

• Publication 525, Taxable and Nontaxable Income

If you participated in an employee stock purchase plan, you do not include any amount in your gross income as a result of the grant or exercise of your option to purchase stock. When you sell the stock that you purchased by exercising the option, you may have to report compensation and capital gain or capital loss. For additional information on tax treatment and holding period requirements, refer to Publication 525, Taxable and Nontaxable Income.

References:

• Publication 525, Taxable and Nontaxable Income

Your initial basis in the stock is what you paid to buy the shares (the option exercise price). This amount is increased by the compensation income amount, if any, you must include on your income tax return when the stock is sold (see below to determine the amount of compensation income). Sales commissions can also increase the basis in your stock but will not reduce the amount of compensation income that you must include on your income tax return.

Under the employee stock purchase plan rules, the amount of compensation income realized when you sell the stock depends on whether the holding period requirements are met and whether you purchased the stock at a discount.

To satisfy the holding period requirements, you must hold the stock for at least one year after it is transferred to you upon exercising the option and for two years after the option is granted. You have not satisfied the holding period requirements if either of these periods is not met.

If the holding periods are met, the compensation income is the lesser of:

1. The amount by which the fair market value of the stock at the time you are granted the option exceeds the exercise price, or
2. The amount by which the fair market value of the stock at the time you sell it exceeds the exercise price.

If the holding period requirements are not met, the compensation income is the amount that the fair market value of the stock, when you exercised the option exceeds the amount you paid for it.

For more information, refer to Publication 525, Taxable and Non-Taxable Income.

References:

• Publication 525, Taxable and Nontaxable Income
• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital Gains and Losses

If the special holding period requirements described below are met, the sale of stock is treated generally as capital gain or loss. However, you may have income reportable as wages on Form 1040 if:

1. The option price of the stock was below the stock's fair market value at the time the option was granted, or
2. You did not meet either or both of the holding period requirement.

The holding period requirements are that you must hold the stock for more than 2 years from the time the option is granted to you and for more than 1 year from when the stock was transferred to you. If you do not meet either or both of these holding period requirements at the time you sell the stock, there is a disqualifying disposition of the stock. The compensation income wages that you should report in the year of the disqualifying disposition is the excess of the fair market value of the stock on the date the stock was transferred to you less the amount paid for the shares. Then increase your basis in the stock by the amount of the ordinary income before calculating your capital gain or loss.

If the holding period requirements are met, but the option exercise price is below the fair market value of the stock at the time the option was granted, you report the discount as compensation income (wages) when you sell the stock. Generally, this compensation income is the lesser of the excess of the fair market value of the stock on the date of the disposition less the exercise price OR the excess of the fair market value of the stock at the time the option was granted less the exercise price.

If the holding period requirements are met and your gain is more than the amount you report as compensation income, the remainder is a capital gain reported on Form 1040, Schedule D (PDF). If you sell the stock for less than the amount you paid for it, your loss is a capital loss, and you do not have ordinary income.

For more information, refer to Publication 525,Taxable and Nontaxable Income, and Publication 551,Basis of Assets.

References:

• Publication 525, Taxable and Nontaxable Income
• Publication 551, Basis of Assets
• Form 1040, Schedule D (PDF), Capital Gains and Losses

The compensation income is reported on line 7 (wages, salaries, tips, etc.) of Form 1040. It is added to the stock's basis used when determining capital gain or loss on the sale of the stock. Any capital gain or loss on the stock sale is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses.

References:

• Publication 525, Taxable and Nontaxable Income
• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

Under the terms of an employee stock purchase plan, you cannot accrue the right to purchase more than $25,000 of stock, valued at fair market value on the day the option is granted, in any one calendar year. The limit is not based on the purchase price.

References:

• Internal Revenue Code §423(b)(8)

A taxpayer generally must include in alternative minimum taxable income the difference between the price paid for stock received pursuant to the exercise of an incentive stock option and the stock's fair market value at the time his or her rights to the stock are freely transferable or are not subject to a substantial risk of forfeiture.

Increase your alternative minimum tax basis is increased by the amount of the adjustment. Your basis for regular tax is not affected by the adjustment.

If you acquire stock pursuant to the exercise of an incentive stock option and dispose of the stock in a disqualifying disposition in the same taxable year, the transaction is subject to regular tax, and no amount relating to the exercise or disposition is required to be reported on Form 6251 (PDF) , Alternative Minimum Tax-Individuals. Refer to Internal Revenue Code §§ 56(b)(3),83 and 422(c)(2). For more information, refer to Form 6251 Instructions, Alternative Minimum Tax- Individuals.

References:

• Form 6251 Instructions, Alternative Minimum Tax- Individuals
• Internal Revenue Code §83
• Internal Revenue Code §56(b)(3)
• Internal Revenue Code §422(c)(2)

Yes. You can use your total net loss to reduce your income dollar for dollar, up to the $3000 limit ($1,500 if you are married and file a separate return).

For more information on capital gains and losses and capital loss carryovers, refer to Chapter 4 of Publication 550, Investment Income and Expenses.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

A loss carryover maintains its character as long-term or short-term and must first be used against gains, if any, in its own category, but can then offset net gains from the other category, as well as up to $3,000 ($1,500 if married filing separate) of ordinary income. If, for example, your only long-term gain or loss is the long-term capital loss carryover, then line 16 of Form 1040, Schedule D (PDF), which nets the net short-term gain or loss against the net long-term gain or loss, will apply your loss carryover against your short-term gain. After that, any remaining net loss will be allowable as a deduction against up to $3,000 ($1,500 if married filing separate return) of your ordinary income. The remainder will be available to be carried over to the following year as long-term loss.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

No, long-term capital gains and losses must first be combined to arrive at net long-term gain or loss before the result can be netted against the net short-term gain or loss. If you follow the Form 1040, Schedule D (PDF), Capital Gains and Losses, Parts 1 and 2, line-by-line, the form will perform the netting for you in this order.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

Before a loss from one category, short or long term, can offset gain from the other category, the losses and gains from each category must be combined to arrive at a net gain or loss from that category. Then, the net gain or loss from each category is combined.

When you carry a capital loss over to the following year, it retains its character as long-term or short-term and must be first combined with the other entries in its category. There is a capital loss carryover worksheet each year in the Form 1040, Schedule D Instructions.

Refer to Reporting Capital Gains and Losses in Publication 550, Investment Income and Expenses .

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

Generally, gain or loss is realized on a short sale when you deliver the stock that "covers" the short sale, not at the time you sell short. Gain (but not loss) on a short sale may be required to be recognized earlier under constructive sale rules if the taxpayer subsequently acquires the same or substantially identical property to the property sold short.

Refer to Constructive Sales of Appreciated Financial Positions in Chapter 4 of Publication 550, Investment Income and Expenses for more details and exceptions.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

This can be confusing with a short sale since it is really a two-step process. The date acquired is the date that the transaction closes, which is the date you deliver to the lender the stock (or other assets) that cover the short sale. The date sold is the date you sell the borrowed stock (or other assets).

Normally, the short sale of a capital asset is considered to result in short-term gain or loss since the stocks (or other assets) that are delivered to "cover" the short sale are purchased the same time as the delivery. However, if stock held by the taxpayer for greater than one year is used to cover the short sale, then the gain or loss is long-term.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

If you are able to defer the reporting of gain or loss until the year the short sale closes, you will need to attach a statement to your Form 1040, Schedule D (PDF) explaining the details of your short sale and that it has not closed as of the end of the year. This will allow you to reconcile your Form 1099-B (PDF) to your Form 1040, Schedule D (PDF) and still not recognize the gain or loss from the short sale. Include your name as it appears on the return and your social security number.

For more on these rules and the rules for put options and wash sales refer to Chapter 4 of Publication 550, Investment Income and Expenses.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

The IRS is not notified of a stock split.

It is your responsibility to accurately report your income on your return in the year you sell shares of stock and to fully disclose details of the sale on Form 1040 Schedule D. Part of that disclosure is to state the per share basis of the stock sold, which should take into account a stock split.

The broker of the sale reports the proceeds of the sale to the IRS on Form 1099-B. The 1099-B also shows the recipient's identity, the payer's identity, and the CUSIP Number that identifies the securities sold.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

The holding period of the stock you received as a result of the stock split begins on the same day as the holding period of the original stock.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

Reverse splits are where your number of shares in a company's stock decreases. Your total basis remains the same; it is your per share basis that increases. You must divide your basis in the old shares by the number of new shares. For example, you own 4 shares of stock. Two of these shares have a basis of $15; each of the other two have a basis of $20 each. There is now a one for two reverse split. Now you have two shares. One has a basis of $30 the other has a basis of $40. If you receive cash because of the sale of a fractional share you have a capital gain or loss that is reported on Form 1040, Schedule D (PDF), Capital Gains and Losses . Please see Fractional Shares in Publication 550, Investment Income and Expenses, for further information on the sale of a fractional share.

References:

• Publication 550, Investment Income and Expenses
• Form 1040, Schedule D (PDF)
• Tax Topic 409, Capital gains and losses

No, you generally do not need to pay tax on the additional shares of stock you received due to the stock split. You will need to adjust basis per share of the stock. Your overall cost basis has not changed, but your per share cost has changed.

You will have to pay taxes if you have gain when you sell the stock. Gain is the amount of the proceeds from the sale, minus sales commissions, that exceeds the adjusted basis of the stock sold.

References:

• Publication 550, Investment Income and Expenses
• Tax Topic 409, Capital gains and losses

If a day trader is engaged in the business of trading, the day trader files a Schedule C as any other taxpayer engaged in a business that requires the filing of a Schedule C. There is no publication specific to day traders. But see the Form 1040, Schedule D Instructions. The section "Traders in Securities" has information for day traders.

Internal Revenue Code section 475(f) and Revenue Procedure 99-17 apply only to traders who elect to use the mark-to-market method of Accounting.

References:

• Publication 550, Investment Income and Expenses
• Publication 535, Business Expenses
• Form 3115 (PDF), Application for Change in Accounting Method
• Form 1040, Schedule D Instructions
• Internal Revenue Code § 475(f)
• Revenue Procedure 99-17

If your trading activity is a business, your trading expenses would be reported on Form 1040, Schedule C (PDF), Profit or Loss from Business (Sole Proprietorship) instead of Form 1040, Schedule A, Itemized Deductions. Your gains or losses, however, would be reported on Form 1040, Schedule D (PDF), Capital Gains and Losses, unless you file an election to change your method of accounting to the mark-to-market method of accounting.

See Publication 550, Investment Income and Expenses (p. 72) for guidance on how to make the mark-to-market election. There is no specific form to use for electing the mark-to-market method of accounting. Revenue Procedure 99-17 describes the statement and when it must be attached to your return/request for extension, to make the election. If you elect mark-to-market, you must change your method of accounting. Also attach Form 3115 (PDF), Application for Change in Accounting Method to your tax return for the year of change. The mark-to-market method of accounting cannot be revoked without the consent of the Secretary.

If you qualify and elect to change to the mark-to-market method of accounting, you would report your gains or losses on Part II of Form 4797 (PDF), Sales of Business Property.

References:

• Publication 550, Investment Income and Expenses
• Publication 535, Business Expenses
• Form 3115 (PDF), Application for Change in Accounting Method
• Form 4797 (PDF), Sales of Business Property
• Procedure 99-17
• Revenue Procedure 99-49

You would have to report any capital gains realized on the sale. Even assuming this transaction meets the requirements of an exchange, rather than a sale, the exchange of shares of one fund for those of another is a taxable exchange. This is true even if both funds are within the same family of funds.

References:

• Publication 564, Mutual Fund Distributions

If a child is 14 years old or older and has a requirement to file an income tax return, he or she would report dividends and capital gains no differently than any other taxpayer. If the child is under age 14 and his or her only income is from interest and dividends (including capital gain distributions), the child's parent can make an election to include the income on the parent's return. If the parent make this election, then the child does not have to file a return. The election is made on Form 8814 (PDF), Parent's Election To Report Child's Interest and Dividends.

In order to make the election under Form 8814,

1. the child must be required to file a return,
2. the dividend and interest income cannot exceed $8,000
3. there must be no estimated tax payment made for the year and no prior overpayment applied to the tax year under the child's name and social security number,
4. there must be no federal tax taken out of the child's income under the backup withholding rules, and
5. the parent must be the parent whose return is used for the special tax rules for children under 14.

If a child under the age of 14 has investment income and the parents do not make the above election, the child reports the income as any other taxpayer would. Special rules on how the investment income is taxed, however, may apply. A child under the age of 14 with investment income (interest, dividends, capital gains, etc.) of more than $1,600 may be subject to the parent's tax rate. The special tax computation is figured on Form 8615 (PDF), Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600.

For more information, refer to Publication 929, Tax Rules for Children and Dependents

References:

• Form 8814 (PDF), Parent's Election To Report Child's Interest and Dividends
• Form 8615 (PDF), Tax for Children Under Age 14 Who Have Investment Income of More Than $1,600
• Publication 929, Tax Rules for Children and Dependents

Yes, you report the sale of your shares on Form 1040, Schedule D (PDF),Capital Gains and Losses. Generally, whenever you sell, exchange, or otherwise dispose of a capital asset, you report it on Schedule D.

If the share price were constant, you would have neither a gain nor a loss when you sell shares because you are selling the shares for the same price you purchased them.

If you actually owned shares that were later sold, the fund or the broker should have issued a Form 1099-B. That form is issued without regard to whether there is a gain or loss on the sale. It reports a sale or exchange of an investment asset and sales proceeds.

References:

• Publication 564, Mutual Fund Distributions

You need to reconstruct your records the best that you can. Contact your broker or the mutual fund company for assistance.

Another source of information is your prior year tax returns. If your mutual fund has been reinvesting dividends, those reinvested dividends (which have been used to purchase additional shares in the fund) should have been reported as dividend income on your tax return each year. To compute your total basis, add to the cost of the original shares purchased the amount of all dividends automatically reinvested that were previously reported as income on your prior tax returns and any shares you subsequently purchased.

You can usually also add acquisition fees and load charges you've paid to your basis in your mutual fund shares. If you sell your shares and the sales commission is not subtracted from the sales proceeds on Form 1099-B (PDF), Broker and Barter Exchanges, you can add the commission to the basis of the shares sold. If you receive a distribution that is identified as a return of capital, you must reduce your total basis by that amount.

Refer to Keeping Track of Your Basis in Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

Unless you have acquired shares through gifts or inheritances, your basis is what the shares cost you. Your mutual fund company can often provide you with this information upon request. Another source of information is your broker, if the fund was purchased through a broker. You cannot calculate your basis in your mutual fund shares accurately without this information. You can only claim the amount of basis that you can establish and substantiate with records. You may lose a large part of your basis if you cannot establish the amount of dividends that were reinvested. This is why keeping records is so important.

Another source of information on reinvested dividends is your prior year tax returns. If your mutual fund has been reinvesting dividends, those reinvested dividends should have been reported as dividend income on your tax return each year.

For more information, refer to Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

They would affect your total basis and total number of shares if they were reinvested in the mutual fund. Add the reinvested dividends and capital gains that you have reported as income on your tax return to your total basis. You will also own additional shares in the fund because the dividends and capital gains have been used to purchase shares. If you are going to be using an average basis method to determine per-share basis on sales, be sure and keep records of all your mutual fund activity until you no longer own any shares in that fund.

There is a worksheet to help you keep track of your number of shares and your basis in Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

A return of principal (or return of capital) reduces your basis in your mutual fund shares. Unlike a dividend or a capital gain distribution, a return of capital is a return of part of your investment (cost). However, basis cannot be reduced below zero. Once your basis reaches zero, any return of principal is capital gain and must be reported on Form 1040 Schedule D (PDF), Capital Gains and Losses.

References:

• Publication 564, Mutual Fund Distributions

You are referring to meeting the requirement for "adequate identification." If you can definitively identify the shares sold, you do not need to use the adequate identification rules. You can use the adjusted basis of those particular shares to figure your gain or loss.

The "adequate identification" rules allow you to control which shares are considered sold, even though you may not control which shares are actually sold. If you specify to your broker which shares you want sold prior to or at the time of the sale and they confirm within a reasonable time in writing, then you are considered to be able to "adequately identify" the shares sold, even if the broker actually sells different shares. The confirmation by the mutual fund must be given to you within a reasonable period of time and state that you instructed the broker to sell particular shares.

If you cannot identify the specific shares and you do not want to use an average basis, then you must use the first-in first-out method (FIFO). FIFO and S are both cost basis methods. You may not use either cost basis method if you have previously used an average basis method for that mutual fund on a tax return. Refer to Publication 564, Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions

No. If you subsequently sell some shares in that mutual fund and can identify the shares sold, you can switch to the specific share identification method. Both of these methods are cost basis methods.

To switch to an average basis method, you must have acquired the shares at various times and prices and have left the shares on deposit in an account handled by a custodian or agent who acquires or redeems those shares. Once you elect to use an average basis method, you must continue to use it for all accounts in the same fund. However, you may use a different method for shares in other funds, even those within the same family of funds.

Before using an average basis, be sure your records reflect the disposition of the shares that were reported using the cost basis method (FIFO).

References:

• Publication 564, Mutual Fund Distributions

Yes. You would include in your average basis calculations only those shares that were still held at the time of the sale you are reporting.

References:

• Publication 564, Mutual Fund Distributions

In order to figure your gain or loss using an average basis, you must have acquired the shares at various times and prices and have left them on deposit in a managed account.

There are two average basis methods:

• Single-category method, and
• Double-category method.

Single-category method. First, add up the cost of all the shares you own in the mutual fund. Divide that result by the total number of shares you own. This gives you your average per share. Multiply that number by the number of shares sold. You may have both short and long term gains or losses. Use the FIFO method to determine your holding period.

Double-category method. First, divide your shares into two categories, long-term and short-term. Then use the steps above to get an average basis for each category. The average basis for that category is then the basis of each share in the sale from that category.

Once you elect to use an average basis method, you must continue to use it for all accounts in the same fund. You must clearly identify on your tax return the average basis method that you have elected to use. You do this identification by including "AVGB" in column (a) of Form 1040, Schedule D (PDF).

Refer to Publication 564,Mutual Fund Distributions.

References:

• Publication 564, Mutual Fund Distributions
• Form 1040, Schedule D Instructions

If you are electing or have previously elected to use the double-category method for that mutual fund, you need to do two separate computations; one for long-term and one for short-term. The single-category method requires only one computation of average basis.

References:

• Publication 564, Mutual Fund Distributions

Either write the name of the average basis method used as a notation on Form 1040, Schedule D (PDF), Capital Gains and Losses, or attach a sheet to the Schedule D showing in detail how you computed the basis of the shares sold. Whenever you attach a statement to your return, include your name(s) and social security number(s). Also include "AVGB" in column (a) of Schedule D.

References:

• Publication 564, Mutual Fund Distributions
• Form 1040, Schedule D Instructions

No, you may use a different method, as long as you have not used an average basis method for that fund previously. Once you have elected to use an average basis method to compute the gain or loss on shares in a mutual fund, you must use that same method for the sale of shares from any account in that same fund.

References:

• Publication 564, Mutual Fund Distributions

How you determine the holding period of mutual fund shares you sold depends on which of the two average basis methods you are electing to use. Once you have elected a method, you must use that method for determining the basis of any shares sold in the future from that fund.

You may specify to your broker the category from which the deemed shares are sold. Shares will be deemed sold from that category so long as your broker provides you with confirmation of the sale. If you do not specify or if the broker fails to provide confirmation shares will be deemed sold first from the long-term category.

References:

• Publication 564, Mutual Fund Distributions

If you used the single-category method, the average per-share basis is the same for the shares you still hold as the ones you sold. The next time you sell shares, the per-share basis will remain the same unless you acquired additional shares in the meantime.

If you subsequently sell some shares and have acquired additional shares since the last sale, you recompute the average basis. Divide the total cost of the shares that you hold at the time of sale by the number of shares you hold at the time of sale.

If you previously used the double-category method to compute an average basis, you need to transfer from the short-term category to the long-term category any shares that have been held longer than one year at the time of a subsequent sale. Transfer the shares at the per-share basis for the short-term category computed at the time of the last sale, then recompute the average basis for the two categories. Use the new total cost and total number of shares for each category.

For more information, refer to Publication 564, Mutual Funds Distributions.

References:

• Publication 564, Mutual Fund Distributions

If your mutual fund splits, or adjusts its price, it is treated like a stock split. Your total basis doesn't change after the split, but since you now own more shares without paying any more money, your per-share basis will decrease. To calculate your per-share basis, divide the total cost that you have invested in the fund (minus any shares previously sold) by the current number of shares that you hold.

References:

• Publication 550,Investment Income and Expenses

If a stock within your mutual fund splits, it has no affect on your basis because the shares you own are shares in the mutual fund, not in the stock that split.

References:

• Publication 564, Mutual Fund Distributions

You do not need permission to elect an average basis method for a particular mutual fund when you have used a cost basis previously to report the sale of shares in the fund. If you meet the conditions to use an average basis, you need to clearly indicate on your return that you are making the election. You also need to indicate which average basis method you are using and if any of the shares are gift shares. If there are gift shares in the account and the fair market value of the shares at the time of the gift was not more than the donor's basis, you must include a statement that the basis for gift shares when figuring the average basis is the fair market value at the time of the gift.

If you have already reported the sale using a cost basis, you cannot make this election unless you can do it on an amended return before the due date of the tax return being amended.

However, you do need the consent of the IRS to use a cost basis or to change your average basis method once you have made this election to use an average basis method. This would be considered a change in an accounting method. You would need to request consent to change your method on Form 3115 (PDF), Application for Change in Accounting Method.

For more information, refer to Publication 564, Mutual Fund Distributions, Publication 538, Accounting Periods and Methods, Form 3115 Instructions, Application for Change in Accounting Method.

References:

• Publication 538, Accounting Periods and Methods
• Publication 564, Mutual Fund Distributions
• Form 3115 (PDF), Application for Change in Accounting Method
• Form 3115 Instructions, Application for Change in Accounting Method

A mutual fund is a regulated investment company that pools funds of investors allowing them to take advantage of a diversity of investments and professional asset management. You own shares in the fund, but the fund owns assets such as shares of stock, corporate bonds, government obligations, etc. One of the ways the fund makes money for its investors is to sell these assets at a gain. If the asset was held by the mutual fund for more than one year, the nature of the income is capital gain, which gets passed on to you. These are called capital gain distributions, which are distinguished on Form 1099-DIV (PDF), from income that is from other profits, called ordinary dividends.

Capital gains distribution are taxed as long term capital gains regardless of how long you have owned the shares in the mutual fund. If your capital gains distribution is automatically reinvested, the reinvested amount is the basis of the additional shares purchased.

References:

• Publication 564, Mutual Fund Distributions

Capital gain distributions from a mutual fund are by definition long-term. That's why they appear only in Part II of Form 1040, Schedule D (PDF), Capital Gains and Losses. The annual statement you receive from your mutual fund may list short-term capital gains, but your Form 1099-DIV (PDF) will show those amounts as ordinary dividends in box 1a.

Ordinary dividends (which include the mutual fund's profits from short term capital gains) are reported on Form 1040, Schedule B (PDF), Interest & Dividend Income, or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends, if the total is over $1500. You enter the total ordinary dividends on line 9a of Form 1040 or line 9a of Form 1040A.

The Form 1099-DIV (PDF) has box 1b for "Qualified Dividends." This box shows the portion of the amount in box 1a that may be eligible for the 15% or 5% capital gains rates. See the instructions for Form 1040 / Form 1040A for how to determine the eligible amount and report this amount on line 9b of your Form 1040 or Form 1040A.

Refer to the line 13 instructions of Form 1040 for exceptions when you can enter capital gain distributions directly on line 13 of Form 1040A without having to file Form 1040, Schedule D (PDF).

References:

• Publication 564, Mutual Fund Distributions

You cannot. You did not sell the assets that produced this income, the mutual fund did. All income that is taxed as ordinary income flows through to you as ordinary dividends, whether the income is from interest, dividends, or the sales of short-term capital assets.

In the same manner, you report capital gain distributions as long-term capital gains on your return regardless of how long you have owned the shares in the mutual fund. This is because the asset was held and then sold by, the mutual fund, not by you.

Report your total ordinary dividends (including the short-term capital gains in your mutual fund) on Form 1040, line 9a, or Form 1040A, line 9a, with your other ordinary dividends. You may also have to file Form 1040, Schedule B (PDF), Interest & Dividend Income, or Form 1040A, Schedule 1 (PDF), Interest and Ordinary Dividends.

References:

• Tax Topic 409,Capital gains and losses
• Publication 550, Investment Income and Expenses

Only the capital gain distributions are reported on Form 1040, Schedule D (PDF),Capital Gains and Losses . They are reported in Part II as long-term capital gains. Short-term capital gains are taxed as ordinary income and are therefore treated as ordinary dividends on Form 1099-DIV. They are reported on line 9a of Form 1040 or Form 1040A.

Because many mutual fund companies send out annual fund statements as well as Forms 1099-DIV, or "consolidated statements," some confusion has arisen regarding short-term capital gains. The purpose of Form 1099-DIV is to provide you with information to report income correctly on your tax return.

The annual report often breaks down the income from fund activity as dividends, tax-exempt dividends, short-term capital gains, long-term capital gains, returns of capital, and undistributed capital gains. Form 1099-DIV, on the other hand, will show only ordinary dividends (which includes the fund's short-term capital gains), capital gain distributions, and returns of capital (nontaxable distributions), and qualified dividends.

Mutual fund companies may combine the annual fund information with the Form 1099-DIV information into a consolidated statement. If this is what you receive, look for the part of the statement identified as the Form 1099-DIV or that contains language such as "in lieu of Form 1099-DIV."

References:

• Tax Topic 409, Capital gains and losses
• Publication 564, Mutual Fund Distributions

No. The kind of income the assets in the fund earn is tax-free. When you sell your shares in the fund, a taxable gain or deductible loss is realized on the sale. This is true also for the sale of tax-exempt securities such as municipal bonds.

References:

• Tax Topic 409, Capital gains and losses
• Publication 564, Mutual Funds Distribution

You should make an estimated tax payment by January 15th of the next year. If you wait to pay the $7,000 with your return, you may be penalized for an underpayment of estimated taxes. Even if you make an adequate payment of tax by January 15th, you may be assessed an estimated tax penalty by the IRS service center when your return is processed. This is because estimated tax payments are normally made in four equal installments and the IRS will not know your liability occurred in the fourth quarter unless you file Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts.

You may be subject to the penalty if you owe at least $1,000 in tax after subtracting your withholding from your estimated tax liability, and you did not prepay at least 90% of your current year's tax or an amount equal to 100% of your previous year's tax. (The latter percentage is higher for higher-income taxpayers with adjusted gross incomes from the previous year of more than $150,000.)

If you make an adequate payment by January 15th but made no earlier estimated tax payments, use Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts, to compute your penalty. Check the box on the front page selecting the Annualized Income Installment method, and then complete Schedule AI on page 4. When you compute the penalty on page 2 of that form using the numbers from Schedule AI, your penalty will be $0. Even if you did not make the January 15th payment, the annualized income method on Form 2210 may significantly reduce the estimated tax penalty if the income for which there was no prepayment of tax was earned in the third or fourth quarters of the year.

For more information on estimated tax payments and the underpayment of estimated tax penalty, refer to Publication 505, Tax Withholding and Estimated Tax.

References:

• Publication 505, Tax Withholding and Estimated Tax
• Form 2210 (PDF), Underpayment of Estimated Tax by Individuals, Estates and Trusts

Your allowable capital loss deduction for any tax year, figured on Form 1040, Schedule D (PDF), is limited to the lesser of:

1. $3,000 ($1,500 if you are married and file a separate return), or
2. Your capital loss as shown on line 16 of Schedule D.

If you have a capital loss on line 16 of Schedule D that is more than the yearly limit on capital loss deductions, you can carry over the unused part to later years until it is completely used up. Refer to Publication 17, Your Federal Income Tax, or Tax Topic 409, Capital Gains and Losses, for additional information.

References:

• Publication 17, Your Federal Income Tax
• Form 1040, Schedule D (PDF), Capital Gains and Losses
• Tax Topic 409, Capital Gains and Losses

The loss on the sale of a personal residence is a nondeductible personal loss.

References:

• Publication 523, Selling Your Home
• Tax Topic 409, Capital gains and losses

The foreclosure or repossession is treated as a sale or exchange from which you, the borrower, may realize gain or loss. However, if you realize a loss on personal use property, such as your residence, the loss is not deductible. Refer to Publication 544, Sales and other Dispositions of Assets, and Publication 908 (PDF), Bankruptcy Tax Guide, for more information.

References:

• Publication 908 (PDF), Bankruptcy Tax Guide
• Publication 544, Sales and other Dispositions of Assets

If you own securities, including stocks, and they become totally worthless, you can take a deduction for a loss, but not for a bad debt.

Worthless securities are treated as though they were capital assets sold on the last day of the tax year. Report this claim for loss from worthless securities on Form 1040, Schedule D (PDF), in Part 1 or 2 depending on whether you held the stock short term or long term, and write "Worthless"in the applicable column of Schedule D. Keep in mind that recordkeeping requirements for claims for a loss from worthless securities require that you keep your records for 7 years. For additional information, refer to Chapter 4 of Publication 550, Investment Income and Expenses (Including Capital Gains and Losses) and Publication 552, Recordkeeping for Individuals. For more information on bad debts, refer to Tax Topic 453, Bad Debt Deduction.

References:

• Publication 550, Investment Income and Expenses (Including Capital Gains and Losses)
• Form 1040, Schedule D (PDF), Capital Gains and Losses
• Tax Topic 453, Bad Debt Deduction