How-to Guides

Sales of capital assets during 2007 should be separated into short-term and long-term categories. Assets held for one year or less are in the short-term category and assets held for more than one year are in the long-term category. Follow the line-by-line computation on Schedule D (Form 1040) to report your sales and obtain the benefit of the lower rates on qualifying long-term gains.

The computation of your tax liability using the favorable long-term capital gain rates is not made directly on Schedule D, but on worksheets in the IRS instructions. Mutual-fund and REIT investors may be able to apply the favorable rates on the "Qualified Dividends and Capital Gain Tax Worksheet" included in the Form 1040 or Form 1040A instructions, without having to file
Schedule D.
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Gains and losses realized on sales of capital assets held for a year or less are considered to be short term and reported in Part I of Schedule D. Short-term gains and losses are netted in this part. A net gain is subject to regular tax rates. A net short-term loss offsets a net long-term gain, if any, from Part II of Schedule D. A net short-term loss in excess of net long-term gain is deductible up to the capital loss limit of $3,000.
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Gains and losses on sales of capital assets held for more than a year are considered to be long term. They are generally reported in Part II of Schedule D, where long-term gains and losses are netted:

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• A net long-term loss offsets a net short-term gain, if any, from Part I of Schedule D.
• If you have a net long-term gain and also a net short-term loss from Part I of Schedule D, the short-term loss offsets the net long-term gain.
• If you have a net long-term gain in excess of net short-term capital loss (if any), the excess is called a net capital gain and it is this amount to which the favorable capital gain rates apply, as discussed below.

A net capital gain is subject to maximum tax rates that are generally lower than the rates applied to ordinary income. Qualified dividends are subject to the same favorable rates as net capital gains. If your top tax bracket is 10% or 15%, your capital gain rate is generally 5% in 2007 (zero in 2008). This means that a net capital gain and qualified dividends that would otherwise be taxed at 10% or 15% after taking into account your other income are instead taxed at 5%.

If your top tax bracket is 25%, 28%, 33%, or 35%, your capital gain rate is generally 15%.
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If you have a net capital gain you should compute your 2007 regular tax liability on the "Qualified Dividends and Capital Gain Tax Worksheet" in the IRS instructions for Line 44 of Form 1040. On the Worksheet you figure the tax on your net capital gain using the maximum capital gain rates, and the tax on the rest of your taxable income using regular tax rates. The Worksheet must be used instead of the regular IRS Tax Table or Tax Computation Worksheet to benefit from the maximum capital gain rates. The tax liability from the Worksheet is entered on Line 44 of Form 1040.

Please note: On both the Qualified Dividends and Capital Gain Tax Worksheet and the Schedule D Tax Worksheet, net capital gain eligible for the maximum capital gain rates is reduced by any gains that you elect to treat as investment income on Form 4952 to increase your itemized deduction for investment interest.
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Long-term gains on the sale of collectibles such as art, antiques, precious metals, gems, stamps, and coins are considered "28% rate gains." If you sell qualified small business stock eligible for the 50% exclusion or empowerment zone business stock eligible for the 60% exclusion (Section 1202 exclusion), the taxable 50% or 40% portion of the gain is also treated as a 28% rate gain. The 28% rate gains are reported in the "28% Rate Gain Worksheet" in the Schedule D instructions. On the Worksheet, 28% rate gains are reduced by any long-term collectibles losses and net short-term capital loss for the current year, and any long-term capital loss carryover from the previous year.

A net 28% rate gain from the 28% Rate Gain Worksheet is entered on Line 18 of Schedule D and then on the "Schedule D Tax Worksheet" in the Schedule D instructions. Your tax liability on all of your taxable income (including net capital gain and qualified dividends) is figured on the Schedule D Tax Worksheet.

If you have a net capital gain that includes either a net 28% rate gain or unrecaptured Section 1250 gain, you must compute your tax liability on the "Schedule D Tax Worksheet" in the Schedule D instructions to benefit from the maximum capital gain rates. The tax liability from the Worksheet is entered on Line 44 of Form 1040.

If your regular top tax bracket exceeds 28%, net 28% rate gains are taxed at 28% on the "Schedule D Tax Worksheet." If your top bracket is 10% or 15%, that regular rate applies to the gains. If your regular top bracket is 25%, the 25% rate generally applies to the net 28% rate gains. However, if you also have long-term gains eligible for the 15% rate, the worksheet computation may tax all or part of the 28% rate gains at the 28% rate even though your regular top bracket is 25%.

The tax figured on the "Schedule D Tax Worksheet" is entered on Line 44 of Form 1040.
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