Capital Gains and Losses
Every time you sell a security, the Internal Revenue Service (IRS) wants to know two things: did you make money, and how long did you hold it? The answers determine how much tax you owe.
Short-Term vs. Long-Term Classification
The dividing line is one year:
| Holding Period | Classification | Tax Rate |
|---|---|---|
| 1 year or less | Short-term capital gain/loss | Ordinary income rate (up to 37%) |
| More than 1 year (1 year + 1 day) | Long-term capital gain/loss | Preferential rate: 0%, 15%, or 20% |
- The holding period begins the day after purchase (trade date + 1) and includes the day of sale
- For Series 7 purposes, assume a 15% long-term capital gains rate unless the question states otherwise
- Short-term gains are taxed at the investor's ordinary income tax bracket - same rate as salary
Exam Tip: Gotchas
"More than one year" means 366 days minimum. If you buy on January 1 and sell on January 1 of the next year, that's exactly one year; still short-term. Holding until January 2 is required for long-term treatment.
Calculating Gains and Losses
The math is straightforward:
- Capital gain = sale proceeds - adjusted cost basis
- Capital loss = adjusted cost basis - sale proceeds
The $3,000 Rule for Net Capital Losses:
- Capital losses first offset capital gains dollar for dollar (no limit)
- If losses exceed gains, you can deduct up to $3,000 of net capital losses against ordinary income per year ($1,500 if married filing separately)
- Unused capital losses carry forward indefinitely to future tax years; they never expire
Exam Tip: Gotchas
The $3,000 limit applies to NET capital losses (after offsetting all gains). The exam loves testing whether you know that excess losses carry forward indefinitely; they do NOT expire.