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Capital Gains Outline

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This is an extract of our Capital Gains document, which we sell as part of our Taxation Outlines collection written by the top tier of Harvard Law School students.

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Capital Gains A. Special Rate for Capital Gains

1. History and Background. Throughout almost the entire history of the income tax, capital gains have been treated preferentially. The distinction between capital gain and ordinary income has been one of the major sources of income tax complexity. That is in part because "capital gain" is a creature of tax law, without a direct analogue in either economics or accounting.

2. Noncorporate Taxpayers. Currently, the holding period is 12 months to receive longterm capital gain treatment. Determining the tax on an individual's capital gains involves a twostage netting process. First, the taxpayer must separately net shortterm gains and shortterm losses. Then, the net shortterm gain or loss is netted against the longterm gain or loss. If the taxpayer has both net STCG and net LTCG, each is taxed at its respective rate. However, if the taxpayer has a net shortterm (longterm) loss, this can be used to offset longterm (shortterm) gain. If both shortterm and longterm capital losses exist, they are simply added together.

3. Capital Loss. Excess capital loss offsets up to $3,000 of ordinary income each taxable year. Any excess not allowed in one taxable year can be carried forward indefinitely until completely utilized. "Excess capital loss" is the lesser or $3,000 or the taxpayer's "adjusted taxable income" (taxable income before the standard deduction and personal exemptions are taken).

4. Capital Gain on Small Business Stock. If a taxpayer holds stock from the date of issuance from a qualified small business (net worth less than $50 million) for at least five years, up to 50% of the gain is excludable. The remainder is taxed at a maximum 28% rate.

5. What is a Capital Asset? Capital assets include all property held by taxpayers that is not subject to an explicit statutory exception. Exceptions exist where property is "held primarily for sale to customers in the ordinary course of trade or business," for "accounts or notes receivable acquired in the ordinary course of trade or business," for "supplies regularly consumed by the taxpayer during the ordinary course of trade or business," and for real or depreciable property, which is governed by SS1231.

6. Held for Sale. Seven factors are considered in determining whether sales of land are considered sales of a capital asset or sales of property held primarily Page 1 of 3

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