 and welcome to the session. This is Professor Farhad and this session we're going to have an introduction to capital gains and capital losses. This topic is covered in an income tax course, the CPA exam regulation section and the enrolled agent exam. As always, I would like to remind you that you my viewers is to connect with me on a professional level, such as LinkedIn, or if you are a Facebook user, please like my Facebook page and you could connect with me on a personal level on Facebook. I want to make sure you subscribe to my YouTube. This is where I house all my lectures so you are always aware of any additional lectures I do add to my catalog. I do also have a website where I list all my courses organized by chapter and course. Now why do we need to differentiate between capital gains and losses versus others, other gains and other losses? Here are some of the reasons. Capital gains, they could be taxed at a lower rate. The losses, if they are capital losses, they could be deductible up to $3,000. So that's why we have to differentiate between capital gain and capital losses. So that's the reason. So capital gain and losses must be separated from other types of gain and losses because long-term capital gains taxed at a lower rate than the ordinary gains and the net capital loss is deductible up to $3,000. Now for something to be capital gain or a capital loss, it all depends on the asset that we are selling and basically we have three types of classification of assets and it all depends on the characteristics. The first is the tax status of the property. The tax status of the property tells us what type of asset are we working with? What type of assets are we working with? So the tax status, it tells us the character of the asset and how is the character determined? It's determined by the purpose and the use. I will explain. So first let me list to you the three types of assets we could have. We could have capital assets, we could have section 1231 asset, we could have ordinary assets. So those are the three types of assets and depending on the asset, depending on the tax status of the property, the transaction will be taxed separately. Now in this section, we're going to focus specifically on capital asset and because of capital asset, we will have capital gains and capital losses. But let's talk about capital asset in general. I'll give you an example, capital asset, a truck. I'll give you an example of section 1231 asset, a truck. I'll give you an example of an ordinary asset, a truck. Hold on a second, this doesn't make any sense. Well, because it all depends on the purpose and the use of the asset. Let me explain. Well, what is a capital asset? Well, a capital asset is a personal use asset, okay, or in the most investment asset. So a capital asset, what we say is a capital asset is a personal use asset. So what could be a personal use? So there we go. I'm going to put it right here. Personal use and most investments, most investment asset, most investment assets. And what are we talking about? Most investment assets to be more specific stocks, bonds as an example, okay. So could you have a truck? Could you own a truck for personal use? Sure you can, okay. So a truck is an example of a capital asset and capital assets are under section 1221. So this is what capital assets are. Any asset that you use for personal use, a truck, a car, a computer, furniture, your tablet, your cell phone, those are all capital assets. If you own stocks, if you own bonds, those are capital assets, okay. Let's talk about section 1231 asset. And I gave an example, a truck. Hold on a second, you just told me the truck is a personal use asset. Yes it is. Can't you also have a business, like a landscaping business, and also own a truck for business use? Is it possible? Can you have a truck for business use? And the answer is yes. So a truck is a section 1231 asset. How did I determine it's a section 1231 asset? It's being used in a business. It's a real property that's used in a trade or business. It's a truck. Now also real property like building, any building, any land that's used in a trade or a business, section 1231. Now don't worry, we're going to talk about much more about section 1231. I just want to let you know that section 1231 are real property and depreciable property which we should be familiar with those terms real and depreciable property used in trade or business. A truck is an example, okay. So this is a truck. This is section 1231, okay. Now let's talk about ordinary asset. An ordinary asset is a catch all category. What does that mean? It means if the asset is not 1231, if it's not a capital asset, if it's not 1231 asset, then it's an ordinary asset. And I'll give you an example, a truck. Now we're back to the truck example. Okay, well guess what? What happened if you are in the business of buying and selling trucks? That's what you do. You buy and sell trucks. You're like a dealership. Then guess what? The truck is considered inventory and inventory is considered an ordinary asset. Now hold on a second. What happened when you sell this inventory? When you sell this inventory, you might sell it on account. You might have an account receivable or a notes receivable. Well guess what? Account receivable and notes receivable are ordinary asset. So this I'm just giving you some examples that you're going to see again and again as used as ordinary asset. Okay, but we're going to talk about ordinary asset a little bit more. So the first thing you want to know is the differentiate between what's a capital asset, what is section 1231 asset and what asset is considered ordinary asset. And don't worry, I'm going to discuss them a little bit further on the next slide. This is just an overview. Basically, I'm going to rehearse what I just said. Okay, so in case you're like I'm not really following here, you're going to see next on the next slide a little bit more formal. Also the way a transaction is taxed is depend on the manner of the property disposition. So you can generally speaking, when you dispose of the property, you can sell it, you can exchange it. And remember, we talk about exchange in chapter 13 or in the prior chapter and we talk if it's exchange, sometimes it's taxed a third, sometimes it's not. So depending on how you dispose of the asset, it gets taxed. Generally speaking, we're going to be dealing with sales and we already dealt with exchanges, or you could dispose of the asset if somebody stole it, casualty loss or condemnation. Those are also other form of disposition. Okay, the holding period of the property also matters because the way a property is taxed depending on the holding period, how long you held the property. So we have simple rules. If you held the property one year or less, so notice it's equal to one year. If you held it one year or less, it's considered short term. If you held the property greater than one year, it's considered long term. And just this is like kind of telling you upfront, long term, they have lower tax rate. So you want the property to classify as long term because it's going to give you lower tax rate. Also just remember any inherited property is always long term because you have no control of when someone dies and when they gave you that property. Gifted property see the related lecture because I'm not going to explain this, I explain this in a 30 minute lecture. So this is just an overview. Let's talk, so what I'm going to focus next is capital assets. So I'm going to take this capital asset here and talk about capital asset. Okay, so what are specifically capital asset? I'm going to repeat myself. Personal use asset, assets, not asset, and most investment assets. Think of it stocks and bonds. Remember personal use assets are not deductible. So if you sold your old car, if you sold your old textbook, if you sold your old toys, whatever you have and you sold them, if you incur losses, losses are not deductible. However gains are obviously taxable. Okay, we don't have to mention this. Capital losses are not personal use assets, which are investment assets. So capital losses are deductible up to 3000 and this is we're talking about personal taxes, not corporate personal taxes. Okay, so how does the IRS define section 1221, which is capital asset. They define capital asset as the following. It's everything except inventory, which I told you inventory is ordinary asset, notes and accounts receivable acquired from sale of inventory or performance of services, ordinary asset. So I'm just telling you also what ordinary assets are, which are not capital asset. Real property and depreciable property used in a trade or a business is section 1231 asset. I already told you this. A patent invention model or design, whether it's patented patented or not a secret formula or process certain copyright, literal musical artistic composition or letters, memoranda or similar properties, those are not capital asset and I'm sure there's other list. Certain publication of US government supplies use in a business. Those are not those. This is a list that is not capital asset. That's not capital asset. So that's a review. So what does capital asset include? Once again, it includes asset held for investments, stocks, bonds, land, if you are holding the land for investment purposes, personal use asset, residency and car. I just said this like five times already. I want to make sure you know what capital assets are. Miscellaneous asset identified by Congress. We don't have to worry about this, but if you're interested, you could look it up on congress.gov. One more thing, non-business bad debt. In other words, a personal bad debt is treated as short-term capital loss and a year it becomes completely worthless. So regardless whether you hold it for a year or less, it's always short-term capital loss. So if you lend someone money and they end up not paying you, then you have a short-term capital loss. Now talking about capital asset, when you sell a capital asset, when you sell a capital asset, and this is we're talking again individual, not corporation, because corporation rules will have different rules, simpler but different. We'll talk about this later on when we talk in the corporation chapter. Capital gains and capital losses are subject to special tax treatment. So we have four possibilities and I did cover those in chapter three. We're going to cover them again. So when you sell a capital asset, you're going to have short-term capital gain, short-term capital gain. You could have short-term capital loss, short-term capital loss. Remember short-term means you held it for one full year or less. Then you could have long-term capital gain, long-term capital gain or long-term capital loss, long-term capital loss. So those are the four categories. So I'm going to first discuss the short-term gains. So when you have a short-term gain, you sold a capital asset and you have a gain and you happen to hold this asset for less than a year. You know what a capital asset is. You know what short-term is. Now you held it less than a year. What's going to happen is this. You're going to be taxed at your ordinary rate. Whatever your ordinary rate is, whatever your tax bracket that you fall in, it's going to be taxed. So short-term capital gain could be taxed up to 37% because that's the highest ordinary rate, not 37%, up to 37%. So some individuals, they are in the 37% tax bracket. Remember we have many tax brackets. Go back to chapter 3. Those are new tax brackets. Otherwise I would have rehearsed them in a moment now, but I just, I don't know the different categories yet. I haven't memorized them. So you could have several, I believe four or five brackets. You could fall in one of them. So if you have any short-term capital gain, you're going to be taxed depending on your ordinary rate. Okay. I'm going to keep the long-term for the next slide. So I want to make sure we differentiate between short-term and long-term. So short-term is easy. Short-term equal to your ordinary rate, whatever your ordinary rate happens to be. It could be 5, 10, 15. I don't know what they are. I should have listed them here, but that's too late. Okay. Long-term capital gain. Long-term capital gain, we treat them a little bit special because long-term. So they're going to be taxed at the lesser of, lesser of your ordinary rate, whatever your ordinary rate, depending on your tax bracket, or something we called long-term capital gain, alternate use, or alternative alternative rate. It should be alternative rate. Okay. Or long-term alternative rate, not alternative use, alternative rate. Okay. Which we're going to see what the long, the alternative rate is. So, so let's just take out the short-term capital gain. We already talked about this. And for now, certain depreciable property used in a trade or a business, just let's take this one out, the 25%, we'll talk about this maybe later on, section 1250. Okay. So what happened is this, when you sell a capital asset and it's a long term capital gain, you end up with a long-term capital gain. What is your taxes? Well, first you have to determine, is this a collectible? If it's considered a collectible, like a piece of art. Okay. A collectible. Then it's your ordinary rate or 28%. So the alternate rate here is 28%. Very easy. The alternate rate is 28%. Okay. It's very simple. The alternate rate is 28%. So it's either your ordinary rate, your ordinary rate could be 15. Your ordinary rate could be 37. Okay. If it's 37, use 28. If it's 15, you would use 15. The lesser of these two. That's simple. If it is not a collectible, so we're done with the 28%, it only applies for collectible. If it's not a collectible, you are left with 0, 15 or 20%. So your long-term capital gain could be 0, which is, you don't have to pay taxes on it. It could be 15% or it could be a whopping 20%. So when do we use 0? When do we use 15 and when do we use 20? Again, this is a review. We use 0%. If your taxable income does not exceed 77,200 and you're made it filing jointly, now if you're single, made it filing separately, it's 38,600 and ahead of a household, 51,700. Simply put, if your taxable income is below these figures, depending on your filing status, then you don't have to pay taxes if your capital gain is a long-term capital gain. Simply put, you don't make a lot of money. The government said, you know what, you held that asset for longer than a year, we're going to give it to you tax-free. When does the 15, oh, let's move to the 20% because it's easier to do it that way. When do you pay 20% on long-term capital gain? And you kind of guessed it when you make a lot of money. 20% of lies, if your taxable income, if you're married filing jointly and your taxable income exceeds 479,000, now you're considered to be making decent amount of money. I wouldn't say good, but decent, this is, let me put it here, I'll take it decent, okay, decent amount of money, but at all, it's all relative. Now remember, if you're making 479,000 a year married filing jointly, make sure don't live in a neighborhood with like, the home is like $5 million because it's not going to give you any value, okay? So everything is relative, okay? 479 is a decent amount of money if you live conservatively, okay? So don't, you know, if you're making that much money, go live in a really rich neighborhood, you're no one at that point, okay? So back to what we need to do. So when does the 20% applies? The 20% applies when your income exceeds that much, if you're married filing jointly, single 425,800, that's a good amount for a single individual and head of a household and married filing separately, okay? So we're done with zero, you don't make a lot of money, 20% where you make more than these amounts, depending on your filing status, and who uses 15%? Everybody else, which is in between those two. Everybody else that makes more, if you're married filing jointly, more than 77, but less than 479, you're in the 15% your capital gain is, again, 15%, let me just repeat myself, 15% or your ordinary rate, whichever is lower. Usually the alternative rate is lower, but I am not going to make that statement because, you know, we could have a situation where your ordinary rate is higher, but generally speaking, it's the lower of ordinary rate or long-term capital gain. So hopefully you understand how introduction of what is a capital asset, how do we classify something as capital asset? Remember, we have, depending on different things, it's by determining its purpose and characteristic, we need to know what a 1231 asset is, don't worry, we're going to talk about this much, much later on. So 1231 will be covered later, okay, but know what it is. So you can differentiate between the different assets. So remember, capital assets are subject to different capital gains and different capital losses, right? They are treated differently and that's why we want to make sure we know what is a capital asset, is it short-term, is it long-term, because it's going to affect how it's being taxed, okay? It's taxed differently and depending on the short-term, the holding period basically. If you have any questions about this recording, please email me. If you're studying for your CPA exam, study hard. If you happen to visit my website for additional lectures, please consider donating. Study hard and good luck.