 Hello and welcome to the session in which we will discuss the netting process of capital gains and capital losses. Specifically here we are discussing the capital assets gains and the capital assets losses. As a quick reminder from the prior session you want to make sure you understand the different categories of capital gains and capital losses because this is what we discussed in the prior session. We defined what is capital asset and we discussed briefly the different categories. Under capital losses we could have short-term capital losses and we could have long-term capital losses. Remember for a short-term capital loss you held the capital asset for less than a year. For capital gains remember we have three categories under the capital gains. We could have short-term capital gains from collectibles which are subject to 28% tax rate, under recaptured depreciation 25% tax rate and other long-term capital gains losses which could be subject to 0, 15 and 20% and in the prior session we discuss when do you qualify for 0%, 15 and 20%. So notice capital gains really they have three categories collectibles, under recaptured depreciation and other long-term capital gains. Now the netting process starts by netting short-term capital gain against short-term capital loss. So the first thing you do is you break down the short-term gains with the short-term losses that's the first thing you do then you net out the long-term gains against the long-term losses. So basically you have the short-term and the long-term netted out together. If each of the categories mentioned above has a net gain then the net gain maintained or character whatever that character is collectibles 28% under recaptured depreciation or other long-term capital gains. So what we're going to do we're going to start slowly looking at the first example where we have a situation of gains and see how we net them out then we move into more complex situation where we could have gains losses and different categories and work through the netting process. Before we proceed any further I have a public announcement about my company farhatlectures.com Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead start your free trial today no obligation no credit card required. So the first example we're going to look at the sum of taxpayer has the following gains and losses long-term capital gain of 5000 short term long-term capital loss from collectibles of 2000. So both of these are collectibles first what you do is you net that category by itself and notice here I'm going to put a plus for a gain so we have a 5000 dollar net long-term capital gain sorry plus 3000 not plus 5000 plus 3000 that's the net that's and this is subject to 28 percent because it's collectible long-term capital gain non-collectible 6000 long-term capital loss non-collectible 3800 again here when we net them we have net 2200 and this is going to be subject to 0, 10, 15 percent depending on the taxpayer tax status short term capital gain of 4000 short term capital loss of 3000 we net them out we have 1000 short term capital gain and remember this is going to be taxed as the ordinary rate whatever your rate happens to be for ordinary income you'll be subjected to that because it's a short term capital gain. Now what's the appropriate tax treatment I kind of basically went through it by netting the gains and the losses in each of the three categories we have long-term collectibles of 3000 long-term from non-collectible 2200 and short term capital gain therefore the 3000 is subject to 28 percent the 22 subject to 0, 15 or 20 and the 1000 is subject to the appropriate tax rate for that in the virtual. Now if each of the categories now has a net loss what would happen up to 3000 of that net loss might be deducted against ordinary income. Again what we are assuming here is you have losses from stocks and bonds not from personal use asset and what you can do if you have losses you can use 3000 against ordinary income I told you in the prior session to memorize this the remaining losses are carried forward to offset future capital gains and let's take a look at an example let's assume we have a taxpayer with long term capital gain of 5 long term capital loss of 8 we have a negative 8 negative 3000 here overall we net them out negative 3000 and this is long term we have short term capital gain of 4 short term capital loss of 1 we have a negative thousand and this is short term capital loss what is the appropriate tax treatment and losses listed above well guess what we have losses all losses so what we can do we can use 3000 so notice in total we have 4000 what we're going to do we're going to take 3000 and this is going to be good that's 3000 will offset ordinary income and what's left is 1000 will be carried forward for future years either computed against gains or used to offset ordinary income so the taxpayer can deduct 3000 of capital loss against ordinary income that's important but basically it's a good thing for example a person like me who always you know not good in trading stocks incur losses so I can use this 3000 and the remaining 1000 would be carried forward well I'm unlucky basically now what if some categories have net losses while other have net gains now we have to kind of deep dive deep into the netting process it becomes a little bit more not challenging or complicated I would say we just have to make sense out of it so let's work this let's first look at the at the rules okay if we have a net short term capital loss okay it's netted against long term capital loss it's netted against that starting with a 28% white 28% if you want to take advantage why not start with the gains that has the highest rate so when we have this short term capital loss first we knock out the 28% if anything left we knock out the 25% if anything left from the losses we take care of the 0 15 and 20% what if we have long term capital loss which is the 0 15 20% we have long term capital loss in this category well good guess what same concept we're going to start with the 28% basically not the same concept we're going to start with the 28% then move to the 25 and any remaining is netted against short term capital gains because first you have to first the long term capital loss will have to take care of the long term capital gains then we move to the short term if anything left so first think of it first you have to clear your category your category is long term so clear any gains in the long term and if you still have losses you could move to the short term what if you have long term capital loss from the 28% class well that's netted against now the 25 because there's nothing higher than the 28 you start with the 25 then you move on to the 0 15 and 20 again you start with within your category which is the long term category and if there's anything remain you will go to you netted against short term capital loss now bear in mind that the 25% will always have a capital gains there is no loss section for the 25 unrecapture depreciation there is no such thing as capital loss for that now the best way to illustrate this is to actually look at an example so we have long term capital gains from collectibles 15 000 long term capital loss from collectibles 23 overall we have a loss of if my math is right of 8 000 and this is the 28% loss we have long term capital gain for the 0 15 20 of 5000 long term capital loss of 0 we have plus 5000 in this category gain we also have short term capital gain of 12 000 short term capital loss of 2 overall we have a gain of 11 000 so what is the appropriate tax treatment so here's what i want you to do first first think of them as they're playing in two different leagues we have two leagues we have this is one league long term and short term so before you move into the other league you have to kind of clear your own league clean clear your own club or your own category so what's going to happen the the 8 000 of the 28 percent the first thing it's going to do it's going to knock out this game and as a result when we net them out we're going to still have we're going to have remaining negative 3000 i'm sorry negative 5000 no negative three this is a five my handwriting i can't even read my own handwriting we're going to have negative 3000 the 28 percent category now we are done with this we're done we we cleared our tournament now we're going to move into the short term now this 3000 can clear 3000 of the short term capital gain and what we're left with is positive 8 000 short term capital gain so this is what works first the gain and losses within each category are netted out so we net out so eight five and three then we there's no sure no short term capital loss so the net long term collectible of 8 000 are first netted against the three as we mentioned then the remaining 3000 is then netted against the 11 and we're left with 8 000 and how is that 8 000 taxed it's taxed at the ordinary tax rate it's short term basically whatever your tax rate is then you're going to be taxed based on that it's like your regular income simply put let's look at another example we have long term capital gain from collectible of 15 long term capital loss of 10 overall we have plus 5000 and this is the 28 percent category we have long term capital gain of five long term capital loss of two we have 2000 in this category the 0 15 and 20 percent we have long term capital gain from the 25 percent class of 4000 this is plus four we have short term capital gain long term capital gain short term capital gain short term capital loss netted out at negative two again the first thing we're going to do we're going to separate the league we're going to separate them into short term and long term okay what do we have here we have losses from this category well think about it if you have losses what would you prefer would you prefer that 2000 offset the 5000 or would you prefer that offset the 4000 I would say I would rather be offset the 28 percent the 5000 indeed so when we net those two out we're going to end up with plus 3000 at 28 percent and this one still remains plus 4000 at 25 percent now in this league we already netted the short term we netted out to 2000 now we have this as a loss how are we going to treat this loss well again what would you prefer this loss to do would you prefer to reduce your 4000 or your 3000 and I hope you know you prefer you prefer that you would net it out against the 28 which would kind of keep us plus 1000 so this 2000 would reduce this by 2000 so we're remaining with 1000 28 percent and 4000 25 percent so this is how we net them out so first each category separately the 5000 for long term capital gain 2000 losses and 4000 gains then we have the net short term capital loss of 2000 so the net long term of 2000 is netted first against the collectibles and what left is 3000 this is what we this is what I showed you the net short term capital loss of 2000 is netted against the 3000 and what left is is a thousand so this is what we are left with as a result the long term capital loss will be 28 percent 1000 and the 4000 is left for the which is we could not reduce that let's look at another example long term capital gain from collectible a thousand long term capital loss from collectible zero so we have a plus 1000 28 category long term long term capital gain of three long term capital loss of eight net them out we have a loss of five we have long term capital gains from 25 zero we don't have this category short term capital gain of three long term short term capital loss of zero we have negative three once again the first thing you do you separate the long term from the short term and you net them out this 5000 it's going to wipe out the 28 and we're going to be left with negative 5000 I'm sorry negative 4000 0 15 20 category now guess what we have losses here what are we going to do I'm sorry this is a gain this is plus three well if we have if we still have losses here what's going to happen this losses now it's going to net it's going to wipe out all the gains that were left with is negative 1000 in losses negative 1000 in losses 0 15 20 percent guess what we're not done we're going to take this 1000 and deduct against ordinary income because we could deduct up to 3000 so what happened this $5000 loss long term long term capital loss wiped out the gain on the collectibles wiped out the gains on the short term capital gain and we still have a thousand of losses we were able to use against our ordinary income not bad at all not bad at all so we're able to use it so first net net each category 1000 5000 3000 then the net long term first netted against the collectibles so we're left with four this is the four here then the net loss of 4000 netted against the three what were left is with a thousand now the entire remaining capital loss may be deducted against ordinary income since we can deduct up to 3000 now this is confused people simply put I showed you on the prior slide where you can deduct it it's basically a freebie from the not freebie but it's a good deduction I prefer if it was like 5000 or 10 000 because a lot of people they buy investments and they incur losses I wish they can they can increase that limitation to 5 or 10 000 but again they don't want people to take risks you don't want them to encourage taking risk but at least they give you 3000 so if you're talking $3000 and you're in the 30% tax bracket you basically save a thousand dollar on your taxes so okay you had a 3000 of losses basically the government allow you to deduct that 3000 and if you're in the 30% tax bracket you'll get it basically saving a thousand dollar on your tax bill this is the benefit of it now capital gains capital gains capital losses from capital assets is a very important topic the taxation of it so what should you do now go to far hat lectures whether you are a CPA EA candidate accounting students you really need to understand this topic inside out capital asset is very important section 12 21 good luck study hard and of course stay safe