You survived a turbulent stock market, making a little profit on a couple of stocks and dumping some dogs just in time. Well, the ride isn’t over yet. Buckle up and get ready to report your transactions to the Internal Revenue Service.
If you sold a stock or other property, regardless of whether you made or lost money on it, you have to file Schedule D. This two-page form, with all its sections, columns and special computations, looks daunting and it certainly can be.
Your extra work, however, will likely be rewarded by tax savings. If you lost money, this form will help you use those losses to offset any gains or a portion of your ordinary income. And if you profited from your transactions, it will help ensure you don’t overpay Uncle Sam for your gains.
Timing is everything
When you make money on a sale, you must report the transaction, first on Form 8949 and then transferring the info to Schedule D, using some basic information, including when you bought the asset and when you sold it. This is critical because how long you hold the property determines its tax rate.
If you owned the security for a year or less, any gain will cost you more in taxes. These short-term assets are taxed at the same rate as your regular income, which could be as high as 35 percent on your 2011 tax return. Short-term sales are reported in Part 1 of the forms.
However, if you held the property for 366 days or more, it’s a long-term asset and is eligible for a lower capital gains tax rate — 15 percent or even zero percent, depending upon your income level. Sales of these assets are reported in Part 2 of the forms.
Detailing your transactions
Once you determine whether your gain or loss is short-term or long-term, it’s time to enter the transaction specifics in the appropriate section of Form 8949. All transactions require the same information, entered in either Part 1 (short term) or Part 2 (long term), in the appropriate alphabetically designated column. For most transactions, you’ll complete:
(a) The name or description of the asset you sold.
(c) When you obtained it.
(d) When you sold it.
(e) What price you sold it for.
(f) The asset’s cost or other basis.
Total your entries on Form 8949 and then transfer the information to the appropriate short-term or long-term sections of Schedule D. On that tax schedule you’ll subtract your basis from the sales price to arrive at your capital gain or loss.
Schedule D also asks for information on some specific transactions that do not apply to all taxpayers, such as installment sales, like-kind exchanges, commodity straddles, sales of business property and gains or losses reported to you on Schedule K-1.
Check out the complete list and if any of these apply to your tax situation, you probably would be wise to turn Schedule D and the rest of your tax paperwork over to a professional.
Schedule D also requires information on any capital loss carry-over you have from earlier tax years on line 14, as well as the amount of capital gains distributions you earned on your investments. If distributions, line 13, are your only investment items to report, you don’t have to fill out Schedule D; they go directly on your 1040 or 1040A return.
You also can escape Schedule D if your only capital gain is from the sale of your residence. As long as you meet some basic residency requirements and your home-sale profit is $250,000 or less ($500,000 for married-filing-jointly home sellers), it’s not taxable and you don’t have to tell the IRS about it here or on any other form.
Totaling your transactions
Once you’ve filled in all the short-term and long-term transaction information in Parts 1 and 2, it’s time to turn over Schedule D and combine your asset-sale details in Part 3. This section essentially consolidates the work you did earlier, but true to IRS form, it’s not as easy as simply transferring numbers from the front of the schedule to the back.
Lines 16 through 22 ask for previous entries and direct you to other lines and forms depending on whether your calculations result in an overall gain or loss. A couple of lines in Part 3 also deal with special rates for collectibles and depreciated real estate. Again, in these situations, expert tax advice might be warranted.
When the total of all your capital activities comes up in negative territory, it’s not good investing news, but it is good tax news. Your loss — up to a limit — can offset your regular income, producing a smaller amount of income upon which you have to pay taxes.
The IRS will let you use Schedule D to totally eliminate any capital gains, but if you lost more than you gained, you can only claim up to $3,000 of your losses in one tax year against the regular income you report on your Form 1040. Larger losses can be carried forward to use against gains in future tax years and, if there’s still an excess, can be written off in $3,000 increments against ordinary income until you completely exhaust the loss.
As a bonus, your loss means you’re through with Schedule D. You simply transfer your loss amount to your 1040 and continue your filing work there.
Figuring the tax on your gains
However, when you come up with a gain, the tax paperwork continues. And this is where the math fun begins, especially if you’re doing your taxes by hand instead of using software.
Depending on your answers to the various Schedule D questions, you’re directed to the separate Qualified Dividends and Capital Gain Tax work sheet or the Schedule D Tax work sheet, which are found in the Form 1040 instructions booklet. Basically, these work sheets take you through calculations of your various types of gain income and figure the appropriate taxation level for each.
Be sure you’ve completed your Form 1040 through line 43 (that’s your taxable income amount) before you begin because that’s the starting point of both work sheets. From there you’ll have lots of addition, subtraction, multiplication and transferring of numbers from various forms, with many of the entries seeming indecipherable and redundant.
But if you sold stock or other property, don’t be tempted to simply ignore Form 8949,
And your extra work generally is to your tax advantage. Because regular income tax rates can be more than twice that levied on some long-term capital gains, when you’re finally through with the calculations, your tax bill should be lower than it would have been if you had simply used the standard tax table to find your tax due.