Subchapter P - Capital Gains And Losses

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Section 1201

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Alternative tax for corporations

Section 1201(a) provides that if the regular corporate income tax rate ever exceeds 35 percent, then a corporation's net capital gains shall be taxed at 35 percent.

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Section 1202

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Partial exclusion for gain from certain small business stock

Noncorporate taxpayers may exclude 50% of any gain realized on the sale or exchange of “qualified small business stock” held for more than five years.

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Section 1211

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Limitation on capital losses

Corporate taxpayers must include capital gains in full in gross income but only to the extent that they exceed capital losses.

It does not matter whether the gains (or losses) are long- or short-term.

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Section 1212

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Capital loss carryback and carryovers

Ordinarily a “net capital loss” can be carried back three years and forward five years until it's used up. The amount of net capital loss (whether long or short- term) carried back or carried forward to another year is treated as a short-term capital loss in the year to which it's carried.

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Section 1221

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Capital asset defined

Everything but...

Inventory;
Supplies regularly used in the taxpayer's trade or business;
Real and certain depreciable property used in the taxpayer's trade or business. But if the property is held for more than the short-term capital gain holding period, a gain on a sale or exchange can possibly qualify as a capital gain under the capital gain-ordinary loss rule;
Certain copyrights, literary, musical or artistic compositions, or similar property created through personal effort;
Accounts or notes receivable acquired in the ordinary course of trade or business for services rendered or from sale of property held in inventory or primarily for sale to customers in the ordinary course of trade or business;
Hedging transactions;
Commodities derivative financial instruments held by commodities derivatives dealers;
Certain publications of the U.S. government (including the Congressional Record).

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Section 1222

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Other terms relating to capital gains and losses.

Definitions for capital gains/losses.

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Section 1223

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Holding period of property

The period for which a taxpayer owns property , ignoring the purchase date but including the date it is disposed of , and ignoring fractions of a day.

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Section 1231

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Property used in the trade or business and involuntary conversions

The capital gain / ordinary loss rule:

If Sec. 1231 gains for the tax year exceed Sec. 1231 losses for the year, such gains and losses are treated as long-term capital gains or long-term capital losses for the tax year. However, if Sec. 1231 gains for the tax year do not exceed Sec. 1231 losses for the year, the gains and losses will not be treated as gains and losses from the sales or exchanges of capital assets.

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Section 1233

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Gains and losses from short sales

Short sales give rise to capital gains and losses only to the extent that the property, including a commodity future, used to close the short sale is a capital asset in the taxpayer's hands. Thus, if a securities dealer makes a short sale, ordinary gain or loss results if the stock used to close the short sale was stock held primarily for sale to customers in the ordinary course of his business. But if the stock used to close was held as a capital asset or if the taxpayer was not a dealer, a capital gain or loss will result.

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Section 1234

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Options to buy or sell

A gain or loss attributable to the sale or exchange of an option (or privilege) to buy or sell property is a capital gain or loss if the optioned property is (or would be if acquired) a capital asset in the hands of the taxpayer.

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Section 1234A

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Gains or losses from certain terminations

Code Sec. 1234A(1) treats, as gain or loss from the sale of a capital asset, gain or loss attributable to the cancellation, lapse, expiration, or other termination of a right or obligation with respect to property which is (or on acquisition would be) a capital asset in the hands of the taxpayer.

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Section 1234B

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Gains or losses from securities futures contracts

Gain or loss on the sale, exchange, or termination of a securities futures contract is treated as gain or loss from the sale or exchange of property having the same character as the property to which the contract relates has in the hands of the taxpayer (or would have if acquired by the taxpayer).

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Section 1235

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Sale or exchange of patents

The transfer (other than by gift, inheritance or devise) of all substantial rights to a patent or of an undivided interest in all such rights, by an individual qualifying as holder of the patent (i.e., the inventor and certain purchasers), to a person who isn't “related” to him, is treated as the sale or exchange of a capital asset held for more one year (i.e., as a sale or exchange resulting in long-term capital gain or loss.) (For taxation of capital gains and losses generally).

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Section 1236

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Dealers in securities

To prevent self-serving hindsight classifications by dealers in securities, § 1236 denies capital gain treatment on a dealer's sale or exchange of a security unless it is “clearly identified in the dealer's records as a security held for investment.”

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Section 1237

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Real property subdivided for sale

Section 1237 prescribes a special rule for determining whether a taxpayer holds real property primarily for sale to customers in the ordinary course of a trade or business. Under this rule, a qualified taxpayer can realize capital gains on selling lots or parcels from a tract held for investment, even if the taxpayer subdivided the tract and made active efforts to sell the property. These activities ordinarily result in a determination that the lots are held primarily for sale to customers in the ordinary course of the taxpayer's trade or business, causing the profits to be ordinary income rather than capital gains.

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Section 1239

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Gain from sale of depreciable property between certain related taxpayers

Under § 1239(a) , gain recognized on a sale or exchange of depreciable property between “related persons” is ordinary income even if it otherwise qualifies as capital gain.

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Section 1241

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Cancellation of lease or distributor's agreement

Amounts received by a distributor of goods for the cancellation of a lease/distributor's agreement are considered amounts received in exchange for the agreement

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Section 1242

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Losses on small business investment company stock

For the shareholders of a small business investment company, the worthlessness of such stock gives rise under § 1242 to an ordinary, rather than a capital, loss, and if the loss is not fully used in the year it is incurred, the excess may be carried over under § 172 (net operating loss deduction) as if incurred in the shareholder's trade or business.

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Section 1243

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Loss of small business investment company

Under § 1243 , a loss incurred by a small business investment company on certain stock investments is treated as an ordinary loss, rather than a capital loss.

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Section 1244

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Losses on small business stock

If Section 1244 applies, up to $100,000 of loss (on a joint return) in any taxable year may be treated as an ordinary loss instead of a capital loss.

Section 1244 applies only to the stock of a small business corporation (judged when the stock is issued).

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Section 1245

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Gain from dispositions of certain depreciable property

§ 1245 classifies gain on dispositions of “section 1245 property” as ordinary income to the extent of depreciation deductions taken with respect to the property, even if the gain otherwise qualifies as capital gain.

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Section 1248

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Gain from certain salees or exchanges of stock in certain foreign corporations

Code Sec. 1248 treats the sale of stock of certain foreign affiliates as if the seller had received a dividend from the foreign affiliate to the extent of the foreign affiliate's earnings and profits. If a seller is deemed to have received a dividend under Code Sec. 1248 , the dividend sourcing rules under Code Sec. 861(a)(2) and Code Sec. 862(a)(2) apply. Any gain in excess of the Code Sec. 1248 amount is sourced under Code Sec. 865 , including Code Sec. 865(f).

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Section 1249

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Gain from certain sales or exchanges of patents, etc., to foreign corporations

§ 1249 prevents certain United States shareholders from transferring certain intangible property to a foreign corporation and realizing a capital gain on that disposition. If a United States person, including a domestic citizen or resident, partnership, corporation, or estate or trust, sells or exchanges a patent, invention, copyright, formula, process, or similar right to a foreign corporation in which the shareholder owns more than 50 percent of its voting power, any capital gain realized on that sale or exchange is recharacterized as ordinary income.

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Section 1250

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Gain from dispositions of certain depreciable realty

“Unrecaptured section 1250 gain,” which is long-term capital gain on a disposition of § 1250 property (generally, real property used in business or held for investment) to the extent the gain would be ordinary income if § 1250 required recapture of all depreciation. Gain on a disposition of § 1250 property is usually ordinary income under § 1250(a) to the extent depreciation on the property exceeded straight line depreciation, and unrecaptured § 1250 gain thus is usually gain on the disposition (exclusive of the amount made ordinary by § 1250 ) to the extent of the depreciation that was or would have been allowed to the taxpayer under the straight line method. Unrecaptured § 1250 gain is usually taxed at 25 percent.

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Section 1252

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Gain from disposition of farm land

A recapture provision applies to gain on sale or other disposition of farm land held less than 10 years, where the taxpayer elected to treat any of his capital expenditures for soil or water conservation or for land clearing (under repealed Code Sec. 182 ) as deductible expenses.

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Section 1253

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Transfers of franchises, trademarks, and trade names

A “transfer” of a franchise, trademark or trade name isn't a sale or exchange of a capital asset if the transferor retains “any significant power, right, or continuing interest” with respect to the subject matter of the franchise, trademark or trade name.

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Section 1254

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Gain from disposition of interest in oil, gase, geothermal, or other mineral properties

On certain dispositions of oil, gas, or geothermal property intangible drilling and development costs are recaptured as ordinary income

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Section 1255

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Gain from disposition of secton 126 property

If any property that is acquired, improved or modified by application of excluded cost-sharing conservation payments under Code Sec. 126 , is disposed of prematurely, ordinary income is recaptured.

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Section 1256

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Section 1256 contracts marked to market

A taxpayer must report his gains and losses resulting from section 1256 contracts on an annual basis under a “mark-to-market” rule.

Section 1256 contracts include any regulated futures contract, any foreign currency contract, any nonequity option, any dealer equity options and any dealer securities contracts.

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Section 1257

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Disposition of converted wetlands or highly erodible croplands

Gain on the disposition of land used for farming and which is converted wetland or highly erodible cropland, is ordinary income. Loss is long-term capital loss.

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Section 1258

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Recharacterization of gain from certain financial transactions

Under § 1258(a) , gain on a disposition or termination of a “position…held as part of a conversion transaction” is ordinary income to the extent of the “applicable imputed income amount.” “A conversion transaction is a transaction, generally consisting of two or more positions taken with regard to the same or similar property, where substantially all of the taxpayer's return is attributable to the time value of the taxpayer's net investment in the transaction.” Section 1258(a) was enacted to prevent taxpayers from obtaining capital gains from “transactions the economic substance of which is indistinguishable from loans in terms of the return anticipated and the risks borne by the taxpayer.”

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Section 1259

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Constructive sales treatment for appreciated financial positions

Under § 1259, if an owner of an appreciated security enters into any one of several specified offsetting positions, the security is deemed sold for its fair market value.

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Section 1260

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Gains from constructive ownership transactions

Section 1260(a)(1) limits the amount of gain with respect to any “constructive ownership transaction with respect to any financial asset” that may be characterized as long-term capital gain. The amount of gain that may be characterized as long-term capital gain is limited to the “net underlying long-term capital gain,” which is essentially the amount of gain that would have been long-term capital gain if, during the term of the derivative contract, the taxpayer had held the underlying assets directly. Any gain in excess of this amount is ordinary income

§ 1260(b) imposes an interest charge with respect to deferral of any gain treated as ordinary income under § 1260(a)(1) effected during years the transaction remained open.

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Section 1271

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Treatment of amounts received on retirement or sale or exchange of debt instruments

Generally, amounts received by the holder on the retirement of a debt instrument are treated as received in exchange for the debt instrument. This treatment is a statutory exception to the common law rule that a creditor doesn't make a sale or exchange when he collects an amount due from his debtor.

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Section 1272

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Current inclusion in income of original issue discount

A debt instrument bears OID if its stated redemption price at maturity exceeds the issue price. Under § 1272(a)(1) , the holder of a discount obligation must report OID as gross income as it accrues over the instrument's term.

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Section 1273

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Determination of amount of original issue discount

A debt instrument bears OID if its stated redemption price at maturity exceeds the issue price.

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Section 1274

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Determination of issue price in the case of certain debt instruments issued for property

When § 1274 applies to an instrument that does not bear adequate stated interest, the instrument's issue price is the imputed principal amount, which is generally the present value of all payments under the instrument; if stated interest is adequate, the issue price is the stated principal amount

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Section 1274A

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Special rules for certain transactions where state principal amount does not exceed $2,800,000

No OID arises if the stated principal amount of the installment note (when aggregated with any other notes issued in the transaction) does not exceed $2 million and the parties agree to account for interest on the note under the cash method of accounting.

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Section 1275

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Other definitions and special rules

OID definitions and terms

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Section 1276

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Disposition gain representing accrued market discount treated as ordinary income

Under § 1276 , market discount must be allocated over the period from the date of purchase to the bond's maturity date. The allocation of market discount, however, is less accurate than the allocation of OID, and market discount allocated to the period of a taxpayer's holding is usually taxed only when the bond is disposed of at a gain.

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Section 1277

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Deferral of interest deduction allocable to accrued market discount

If “indebtedness…is incurred or continued to purchase or carry” a market discount bond, § 1277(a) defers deductions for interest on the debt, in whole or part, until the market discount is recognized as income.

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Section 1278

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Definitions and special rules

More definitions, such as market discount.

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Section 1281

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Current inclusion in income of discount on certain short-term obligations

Section 1281(a) requires some holders of short-term obligations to report discount and interest income as it accrues.

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Section 1282

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Deferral of interest deduction allocable to accrued discount

Under § 1282(a) , if a holder of short-term obligations is not required to report discount income as it accrues and does not elect to do so, deductions for interest on debt financing the investment in the obligation may be deferred in whole or in part until the obligation is sold, exchanged, or redeemed.

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Section 1283

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Definitions and special rules

Short-term obligation definitions.

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Section 1286

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Tax treatment of stripped bonds

Section 1286 , enacted in 1982, imposes the OID rules on so-called stripped bonds (i.e., bonds issued with interest coupons, if there is a separation of ownership between the bond and any coupon not yet payable).

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Section 1287

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Denial of capital gain treatmetn for gains on certain obligations not in registered form

Under § 1287(a) , gain on sale or exchange of a “registration-required obligation [that] is not in registered form” is sometimes taxed as ordinary income. Section 1287 is part of a group of provisions enacted in 1982 to restrain issuance of bearer bonds, whose holders, it was believed, often fail to report interest on the bonds.

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Section 1288

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Treatment of original issue discount on tax-exempt obligationss

To the extent the “discount” on State or municipal obligations (whether interest bearing or not) is OID, it is treated as tax-exempt interest. Rev. Rul. 73-112, 1973-1 C.B. 47 . OID on such obligations is accrued in the same manner as OID on taxable obligations.

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Section 1291

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Interest on tax deferral

PFICs, which are foreign corporations with a high percentage of passive income or assets, are subject to special tax rules designed to prevent their U.S. shareholders from deferring the recognition of the income relating to their PFIC investment. Under these rules, generally any gain from dispositions of PFIC shares occurring in a taxable year following the tax year of their acquisition and the income from certain distributions by a PFIC (each an “excess distribution”) are characterized as ordinary income and are subject to an interest charge intended to eliminate any benefits of tax deferral.

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Section 1293

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Current taxation of income from qualified electing funds

A U.S. shareholder of a passive foreign investment company (PFIC) also can avoid the excess distribution regime of Code Sec. 1291 by making and maintaining a qualified electing fund (QEF) election pursuant to Code Sec. 1295 and Reg § 1.1295-1(c) through Reg § 1.1295-1(j). The QEF election is made and maintained separately by each shareholder. Thus, a PFIC can simultaneously be a QEF PFIC and a non-QEF PFIC. A U.S. shareholder who makes a QEF election with respect to a PFIC is not subject to the interest and tax charges of Code Sec. 1291(a) on excess distributions of the PFIC's earnings or gain on the disposition of the PFIC stock. The price of making such an election is that the shareholder must include in its gross income on a current basis its pro rata share of all of the PFIC's undistributed earnings and profits.

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Section 1294

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Election to extend time for payment of tax on undistributed earnings

A U.S. person who is a shareholder in a qualified electing fund (QEF) on the last day of the QEF's tax year 12 may elect to extend the time for payment of any of his undistributed passive foreign investment company (PFIC) earnings tax liability for the tax year.

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Section 1295

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Qualified electing fund

A PFIC is treated as a qualified electing fund (QEF) with respect to a particular taxpayer if that taxpayer makes the election for the tax year with respect to the PFIC and the PFIC complies with the requirements prescribed by regs for determining its ordinary earnings and net capital gain and any other necessary information.

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Section 1296

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Election to mark to market for marketable stock

A PFIC shareholder may make a mark-to-market election for marketable PFIC stock. If the election is made, the shareholder includes in income each year an amount equal to the excess, if any, of the fair market value of the PFIC stock as of the close of the tax year over the shareholder's adjusted basis in the stock. The shareholder is allowed a deduction for the lesser of the excess, if any, of the adjusted basis of the PFIC stock over its fair market value as of the close of the tax year, or the “unreversed inclusions” with respect to the PFIC stock.

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Section 1297

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Passive foreign invesment company

A foreign corporation is a PFIC if it meets a passive income test or a passive assets test. The corporation meets the passive income test if at least 75 percent of its income consists of dividends, interest, and other passive items, and it meets the passive assets test if at least 50 percent of its assets produce passive income. These tests are described below.

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Section 1298

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Special rules

Where a person owns directly or indirectly 50% or more in value of the stock of a corporation, that person is considered to own the stock owned directly or indirectly by or for that corporation in the same proportion as the value of the stock the person owns bears to the value of all the stock in the corporation.