(For a discussion of the basis and adjusted basis of assets, see here.)

The sale of property is generally the first thought I have when I think of the term “taxable event.” There are exceptions but, if an event renders the disposal of an asset taxable, and that disposal was voluntary, then a sale has almost certainly taken place. The key word here is voluntary, in that sales are mostly voluntary. The context in which a sale takes place for tax purposes almost always involves an individual or entity choosing to sell a capital asset, giving rise to a capital gain or loss. In this respect, because so many taxpayers have capital gains at least occasionally, it’s very important to understand what a sale (or trade) is in order to know when a taxable event has occurred.

A sale is the exchange of property for money. So for example, if I were to exchange my house for $200,000 to a buyer, that transaction is a sale. This seems so intuitive, but a proper foundation is the key to understanding. Additionally, the redemption of stocks or bonds is a sale, unless, in the case of stock, the supposed redemption is really just the stock’s dividend or other distribution. What’s a redemption? A redemption occurs when stocks or bonds are sold back to the issuer, typically for cash.

You might be saying, “But I already knew what a sale is.” Okay, okay. Well how about we talk about figuring the gain or loss associated with a sale? First, a gain or loss is derived from the subtraction of the adjusted basis from the amount realized from the sale of an asset. The amount realized is defined as all the things of value you received for that asset, usually just money, minus the expenses incurred during the lead up to the sale. Note that the amount realized also includes amounts paid to you that cover the principal and interest of debt encumbering the asset you just sold, even if you’re not personally responsible for paying that debt back.

As pertains to taxable events, aside from sales, there are also trades, meaning that you don’t exchange cash; you’re exchanging one asset for another. A lot of trades are just classified as bartering and would be subject to income tax, just as if you had sold the asset for cash. However, there are some trades that don’t result in taxable income. For example, if you trade real estate that you held for business or investment purposes for other real property held by the trader for the same purpose, then this type of trade does not yield any taxable income. This is called a like-kind exchange because the two assets are of the same type; they are like-kind. However, if you exchange like-kind property along with dissimilar property, then you must pay taxes on the dissimilar property portion of the trade, and your gain, if any, is the fair market value of the unlike property minus its adjusted basis.

Other types of trades that generally don’t lead to taxable income are: 1) common stock for preferred stock (or vice versa) in the case of a corporate reorganization; 2) swapping shares of stock from the same company; 3) the conversion of bonds into stock, in the case of a convertible bond; 4) property for stock in a corporation where you (or a group) control at least 80% of the voting share after the trade; 5) life insurance policies and annuities traded for other life insurance policies and annuities, respectively; 6) the receipt of stock for your interest in a life insurance policy or annuity; and 7) U.S. Treasury obligations for other U.S. Treasury obligations.

Furthermore, the transfer of property between spouses or former spouses incident to divorce does not give rise to a taxable event, unless the property is transferred in trust and the liability exceeds the basis. The basis that the recipient spouse has in the property immediately upon receipt is the transferor spouse’s adjusted basis immediately before transfer. Moreover, if you transfer sell or trade property between spouses, you generally cannot deduct any capital loss, if there is one. This same general rule applies for all members of your family, which include siblings, half-siblings, parents, grandparents, children, and grandchildren.

Finally, it matters whether you have sold or exchanged capital assets because this determines whether you are privy to capital gain tax rates or ordinary tax rates. For all intents and purposes, all things that you own for personal or investment purposes are capital assets. This might seem like an overly expansive category, and it is. Capital assets include your home, vehicles, stocks, bonds, coins, baseball cards, hairbrushes, forks, knives, couches and other furniture, just to name a few. You can see I’m being insane, but you get the picture, if you own it, it’s probably a capital asset. Note however, that even though personal use property is a capital asset, you cannot deduct a loss from its sale. Furthermore, intangible property can be a capital asset. We’ve already touched on stocks and bonds, but this category also includes musical compositions and intellectual property like patents.

Again, the sale or exchange of capital assets matters for both deductibility of losses and the tax on the gains. Capital losses are deductible to the extent of capital gains and, if there’s a net capital loss, then up to $3,000 ($1,500 if married filing separately). As far as gains go, capital gains are separated into two distinct categories – short term and long term. Short term capital gains result from owning a capital asset for one year or less before its sale. Long term capital gains are derived from a holding period of over a year before divestiture. For the purposes of counting the duration of ownership, don’t count the day of acquisition but count the day of sale. While short term capital gains are taxed just like ordinary income, long term capital gains are taxed at favorable rates of 0%, 15%, or 20% depending on your level of taxable income.

One final note on a peculiar holding period rule, under the wash sale rules, you cannot deduct a loss from the sale of stock or securities when you purchase the same or basically the same investment within 30 days of the initial sale. For example, if I sell Google stock and generate a capital loss and then 15 days later, I buy additional Google shares, I can’t deduct the loss from the initial sale. I have to add the loss to the basis of the later purchased stock and the corresponding holding period of the new Google stock includes the amount of time I held the original Google stock. In this way, the wash sale rule delays the factoring in of the loss from the initial sale until after the later purchased stock is sold.

Report both short and long term capital gains on Schedule D and Form 8949.

For more information on sales, see IRS Publication 17.

If you are having problems with sales, trades, exchanges, capital assets, holding periods, or short and long term capital gains or losses, call Dino Tax Co at (713) 397-4678 or email davie@dinotaxco.com. The first phone consultation is free. Also, consider liking us on Facebook: www.facebook.com/dinotaxco.