Capital Gains and Schedule D

When you sell a capital asset—property owned and used for personal or investment purposes, let’s say—the sale will result in either a capital gain or a capital loss. You report that gain or loss on Schedule D of Form 1040.

The capital assets you’ll most likely report on Schedule D are stocks, bonds, and homes that you sell. Schedule D is also used to report a prior year’s capital loss carryover. If your capital losses total more than your capital gains for a tax year, the IRS limits how much of the excess loss you can claim to reduce your current year’s tax liability. An excess capital loss can be carried forward to the next year.

Use Schedule D to report the following:

• The sale or exchange of a capital asset not reported elsewhere
• Gains from involuntary conversions (other than from casualty or theft) of capital assets not held for business or profit
• Capital gain distributions not reported directly on Form 1040 or effectively connected capital gain distributions not reported directly on Form 1040-NR
• Bad debts not connected with a business

The following items are not capital assets:

• Inventory for sale to customers in the ordinary course of business
• Accounts receivable or notes receivable arising in the ordinary course of business for sales of inventory or services rendered
• Depreciable property used in business
• Real estate used in business
• Any of the following created or owned by you: a patent, invention, model or design; a secret formula or process; or an artistic work, including a literary or musical composition (there are some exceptions here, however)
• A US government publication received for free or for less than the usual price
• A commodities derivative financial instrument held by a commodities derivatives dealer, except for instruments unconnected to the dealer’s normal activities
• A hedging transaction
• Supplies used in the ordinary course of business

Schedule D functions as a summary of all capital gains transactions. You may also need to file Form 8949, Sales and Dispositions of Capital Assets. Part I of the form should be used for the sales of short-term assets that were held for one year or less. Part II is for long-term assets.

As a taxpayer, you use Schedule D to show your total capital gains for the year. The calculations from Schedule D affect your adjusted gross income on Form 1040. If you had a capital loss and, due to limitations on its deductibility, had an excess capital loss to carry forward to the next year, make sure to keep your records so you can accurately input capital loss carryforward on next year’s Schedule D.

This is just an introduction to a complex topic. There are a lot of subtleties in the calculation of capital gains. Be sure to consult with an R&A tax professional for the most up-to-date advice.©