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Subject: Netting capital gains and losses  Date: 12/30/1999 4:39 PM  
Author: ptheland  Number: 24110 of 122648  
Netting out your capital gains and losses or Fishing around in schedule D Most of us are aware that you have to net out your capital gains and losses when figuring up your taxes for the year. But how does all this netting work? Should I be hanging around the local dock to learn how to net my capital gains and losses? Let's try to unravel some of this mystery. First of all, there are a couple of levels of netting that go on. Longterm items are netted separately from shortterm items. Then the long and short are netted together to produce the final result. It's easiest to just look at an example. Long John Silver sold two stocks so far this year. Both were held for more than a year, so are longterm items. He had a gain of $1,000 on his investment in Fishing.com (an internet startup selling trout and salmon online to unlucky fisherman), but a $600 loss on Fish Are Us (a retailer of fishshaped toys for kids). Subtract the loss from the gain and we find that he has a net $400 longterm gain. Now let's say that Long John sells two more stocks before yearend. His investment in Mackerel Industries has turned out to be a real stinker. So he unloads it for a $300 shortterm loss. And Minnow, Inc. turned a small shortterm gain of $50. Net these two items together and Long John has a $250 shortterm loss. Finally we net the shortterm items with the longterm items and find that Long John has a net $150 longterm gain. If you roll this around in the gray matter for a while, you'll find that everything will boil down to one of four situations: longterm gain with shortterm gain longterm loss with shortterm gain longterm gain with shortterm loss longterm loss with shortterm loss Let's look at each of these situations one at a time. Longterm gain with shortterm gain Ahhh – investment nirvana! Everything nets out to a winner. Your taxes here are pretty simple. (Don't worry, though, they'll get more challenging as we go along.) The longterm gain gets the preferential rate of 10% or 20%, depending on your tax bracket. The shortterm gain is taxed with your other income at your marginal rate. Longterm loss with shortterm gain We have to look at two situations here. If the gain is bigger than the loss, you have a net shortterm gain – taxed at your marginal rate. If the loss is bigger, you have a net longterm loss. Up to $3,000 can be used to offset other kinds of income. Any unused amount will carry forward to the following year as a longterm loss. Longterm gain with shortterm loss So you like the Foolish Four, but just couldn't resist dabbling in day trading? Well, again we have to consider two scenarios. If the gain is bigger than the loss, you have a net longterm gain and get to take advantage of the favorable rates for the net gain. If the loss is larger, it is a net short term loss and, just like the previous situation, you use up to $3,000 of the loss against other types of income, with any balance carrying forward to the next year as a shortterm loss. Longterm loss with shortterm loss Have you ever considered index funds? This one looks simple, but there is a twist. By now you know that a maximum of $3,000 in losses will offset ordinary income. So if the total of the two losses is less than $3,000 you're done. But what if the loss is more than $3,000 and some must be carried over to next year? Is the carryover shortterm or longterm? Well, it can be just longterm or a combination of long and shortterm. But it will never be just shortterm. Why? Because you must use the shortterm losses first. So if your shortterm losses are more than $3,000, you carry the remaining shortterm loss, along with all of the longterm loss, over to next year. If the shortterm loss is less than $3,000, you can just total the two losses together, take the $3,000 off, and the balance is a longterm loss carryover to the following year. So the process for determining the longterm or shortterm character of your capital gains and losses can be summarized in three steps: 1. Net your longterm items together 2. Net your shortterm items together 3. Determine which of the above four situations applies to you and follow the instructions there. But there is one more situation. What if you don't have any of one type of transaction – either shortterm or longterm? (Or the really unlikely situation of one of them netting out to exactly zero?) The above instructions still work. Just consider the missing item to be a gain and … Fool on!! ptheland 

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