Achievable IRS EA Part 1

3. Retirement, investment, and supplemental income

Sales, losses, and special capital asset rules

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Sales of capital assets and securities

Definitions

Capital assets: Almost everything owned and used for personal purposes, pleasure, or investment, such as a home, car, collectibles, stocks, bonds, and digital currency held for investment.
Cost basis (basis): The original purchase price of an investment, adjusted for factors like stock splits, dividends, and return of capital distributions.

Capital assets include almost everything you own and use for personal purposes, pleasure, or investment, such as your home, car, collectible items, stocks, bonds, and digital currency held for investment. Inventory and other property held mainly for sale to customers, business accounts receivable, and depreciable property or real estate used in a trade or business are not capital assets. Assets held for one year or less before being sold are short-term transactions, taxed at ordinary income tax rates. Assets held for more than one year before being sold are long-term transactions, taxed at the more favorable capital gain rates. Capital losses offset capital gains in full, but a net capital loss is deductible against other income only up to $3,000 per year ($1,500 if married filing separately), and any excess loss carries over to future years until it’s used up.

Cost basis, also known as “basis,” is the original purchase price of your investment. Cost basis is adjusted for stock splits, dividends, and return of capital distributions and is used to determine the capital gain or loss when the asset is sold. Basis will be discussed in more detail in Part 2-Businesses. Refer to IRS.gov for more information.

A taxpayer who can’t adequately identify which shares of a holding were sold must treat the earliest-acquired shares as sold first (first-in, first-out, or FIFO); average basis can be elected only for mutual fund shares and dividend reinvestment plan shares.

Amount realized and amount recognized

Definitions

Amount realized: The total value received from a sale or disposition of an asset.
Amount recognized: The portion of a realized gain or loss that’s actually taxable - equal to the realized gain or loss unless a specific rule, such as the wash sale rule, defers or disallows part of it.

Amount realized is the total value received from a sale or disposition of an asset, including cash, the fair market value of any property received, and the value of any liabilities assumed by the buyer. Subtracting the adjusted basis (the original purchase price plus improvements) and any expenses associated with the sale from the amount realized gives the realized gain or loss. The amount recognized is the portion of that realized gain or loss actually reported for tax purposes - it equals the realized amount unless a special rule, like the wash sale rule, defers or disallows some of it.

Example:

Chris sold a stock for $$10, 000$ ; his initial cost (basis) was $$2, 500$ . Chris’s amount realized is $$10, 000$ , and his realized gain is $$7, 500$ . The amount recognized is $$7, 500$ , the taxable portion, which in this case is the same as the realized gain.

Short-term capital gain example:

On January 29, 2025 Johnny purchased $100$ shares of XYZ stock, total $1, 000$ . On February 20, 2025, Johnny sold the same shares for $$1, 700$ . Johnny has realized and recognized a $$700$ short-term capital gain. Because he held the shares one year or less, the gain is taxed at his ordinary income tax rate, which depends on his total taxable income.

Short-term capital loss example:

On February 12, 2025, Mary purchased $100$ shares of XYZ stock at $$5$ a share, for a total of $$500$ . On April 25, 2025, the stock went down in price to $$2$ a share, so Mary sold all $100$ shares. Mary realizes and recognizes a short-term loss of $$300$ . Mary will recognize a loss at her own tax rate.

Long-term capital gain examples:

On February 18, 2024, Esmeralda went to a yard sale and bought a silver tea set for $$35$ . Then Esmeralda paid $$85$ to make a minor repair to the silver tea set before she decided to sell it. On May 13, 2025, Esmeralda sold the silver tea set for $$200$ . Esmeralda realized $$200$ , which was the amount she received from the sale, but her $$85$ repair was added to her $$35$ original basis, making her adjusted basis $$120$ . Therefore, Esmeralda recognizes (pays tax on) $$80$ . Esmeralda will have capital gains tax treatment on the sale of the silver tea set.

Long-term capital loss examples:

On March 7, 2023, April bought $400$ shares of XYZ Stock for $$2, 000$ . On April 24, 2025, she sold the same amount of shares for $$1, 800$ . April has realized and recognized a $$200$ long-term capital loss.

Bernard bought a house as an investment for $$38, 000$ and never lived in it. Five years later, he sold it for $$19, 000$ . Bernard has realized and recognized a $$19, 000$ long-term capital loss (had the house been his home, the loss would not be deductible); if he has no capital gains, he can deduct only $$3, 000$ of it against other income for the tax year and carries over the remaining amount.

Stock splits

Definitions

Stock split: When a company increases the number of its shares by dividing existing shares into multiple shares.

In a stock split, a company divides its existing shares into more shares. For instance, a 2-for-1 split means each share is split into two new shares. For example, if Harold owns $10$ shares and the corporation declares a 2-for-1 split for its shareholders, then Harold will receive $10$ more shares, bringing his total to $20$ shares. The total value of your shares before and after the split remains the same. The price per share decreases proportionally to the increase in the number of shares.

Scenario

Company: ABC Corp.
Pre-split price: $100 per share
Investor: Marcus owns $10$ shares of ABC Corp.
Split: ABC Corp. announces a 2-for-1 stock split.

Before the split, Marcus owned $10$ shares at $$100$ each, for a total value of $$1, 000$ ( $10$ shares $$100$ /share = $$1, 000$ ).

After the split, Marcus owns $20$ shares ( $10$ shares $\times 2 = 20$ shares). The price per share is now $$50$ (the original price divided by the split ratio: $$100$ / $2$ = $$50$ ). Marcus’s total value remains $$1, 000$ ( $20$ shares $\times $50$ /share $= $1, 000$ ).

On June 3, 2025, the fair market value of ABC stock rose to $$70$ a share, so Marcus sells $10$ shares of ABC for $$700$ . His amount realized is $10$ shares $\times $70$ /share $= $700$ ; his cost basis is $10$ shares $\times $50$ /share $= $500$ . Marcus will realize and recognize a gain of $$700 - $500 = $200$ .

Remember that Marcus still holds $10$ remaining shares of ABC stock, which he can sell at a later time. Marcus’s tax treatment will depend on the length of time that he has held the shares he had sold.

Wash sales

Definitions

Wash sale: A transaction where a security is sold at a loss and a substantially identical security is purchased within 30 days before or after the sale (a 61-day window), disallowing the loss for tax purposes.

A wash sale is a transaction in which an investor sells a security at a loss and repurchases a substantially identical security within 30 days before or after the sale - a 61-day window that includes the sale date. The wash sale rule applies to stock and securities and to contracts and options to buy or sell them, but not to commodity futures contracts or foreign currencies. A purchase by the taxpayer’s spouse, a corporation the taxpayer controls, or the taxpayer’s IRA also counts. The disallowed wash sale loss is added to the basis of the repurchased security.

Wash sale disallowed loss example:

On January 30, Curtis overheard a hot tip on a stock and decided to buy $1000$ shares of Dit Dit Corporation for $$5$ a share. On February 11, the stock had lost half its value; Curtis got impatient and sold all of his shares to cut his loss. The next day, Curtis repurchased $1000$ shares of Dit Dit Corporation for $$2, 400$ . Curtis will realize a $$2, 500$ loss but cannot recognize it for tax purposes, because he repurchased substantially identical stock the very next day - within the 30-day wash sale window. The $$2, 500$ disallowed loss is added to the basis of the repurchased shares.

Sales of securities are reported on Schedule D, Form 1040, but traders whose trading is substantial, continuous, and regular and seeks to profit from daily market movements (rather than dividends, interest, or capital appreciation) are in a trading business without applying to the IRS and can deduct their trading expenses as business expenses on Schedule C. Sales of personal items for a profit are taxable, but if sold for a loss, are not deductible. Gains on these transactions are capital gains (long-term rates apply if held more than one year).

The basis of inherited securities is their fair market value at the date of death. Inherited property is treated as held for more than one year, so a sale by the heir produces a long-term gain or loss no matter how briefly the heir actually held it.

Gifted property pitfall: property you receive as a gift carries a dual basis. For figuring a gain, you use the donor’s adjusted basis. For figuring a loss, you use the lower of the donor’s adjusted basis or the property’s fair market value on the date of the gift. This keeps a donor from passing along a built-in loss for you to deduct.

Other special property rules are covered elsewhere in the course: installment sales in Capital gains and income, the home-sale exclusion under IRC §121 in Divorce, property, and education planning, and non-business bad debts in Special business deductions, depreciation, and losses.

Options

Buying and selling options. The cost of a put or call is a capital expenditure, not a deduction. If the holder sells the option, the gain or loss is capital, short- or long-term depending on how long it was held; if it expires unexercised, it is treated as sold on the expiration date, so its cost is a capital loss. An exercised call’s cost is added to the basis of the stock bought, and an exercised put’s cost reduces the amount realized on the stock sold. The writer of an option reports nothing when the premium is received: if the option expires, the premium is short-term capital gain; if it is exercised, the premium increases the amount realized (call) or reduces the basis of the stock bought (put).

Section 1256 contracts. Regulated futures contracts, foreign currency contracts, nonequity options (such as commodity futures options and broad-based stock index options), dealer equity options and dealer securities futures contracts held at year-end are marked to market: treated as sold at fair market value on the last business day of the year. Under the 60/40 rule, 60% of the gain or loss is long-term and 40% is short-term, however long the contract was held; the gains and losses are reported on Form 6781 and carried to Schedule D. An ordinary option on a single stock is not a section 1256 contract.

Options an employer grants as pay (nonstatutory options, incentive stock options and employee stock purchase plans) are taught in Earned and investment income.

Mark-to-market tax rules

Definitions

Mark-to-market (MTM): An accounting method that treats assets as sold at fair market value at the end of the tax year.

The mark-to-market (MTM) tax rules primarily apply to traders in securities or commodities who make a specific election under Section 475(f) of the Internal Revenue Code. This accounting method treats certain assets as if they were sold at their fair market value on the last business day of the tax year.

Sales of business property are reported on Form 4797; a net section 1231 loss is ordinary, while a net section 1231 gain (after depreciation recapture) is generally long-term capital gain. Depreciation recapture, including the 25% rate on unrecaptured section 1250 gain, is taught in Special business deductions, depreciation, and losses.

Foreclosures and abandonments (Form 1099-A)

A foreclosure or repossession of property that secures a loan is treated as a sale, and so is abandoning property that secures nonrecourse debt. The lender reports it on Form 1099-A, Acquisition or Abandonment of Secured Property, which shows the debt balance, the property’s fair market value and whether the borrower was personally liable; a lender that also cancels $600 or more of the debt that year may file only Form 1099-C instead. The amount realized depends on the debt:

Nonrecourse (not personally liable): the full debt, even if the property is worth less; there is no cancellation of debt income.
Recourse (personally liable): the smaller of the debt or the property’s fair market value. Canceled debt above that value is ordinary cancellation of debt income, separate from the gain or loss. Abandoning property that secures recourse debt produces no gain or loss until the foreclosure is completed.

For example, a home with a $175,000 adjusted basis, a $180,000 mortgage and a $170,000 value is foreclosed. On a nonrecourse loan, the amount realized is $180,000, a $5,000 gain. On a recourse loan, it is $170,000, a $5,000 loss, plus $10,000 of canceled debt income if the lender forgives the rest, unless an exclusion applies. A loss is deductible only on business or investment property, never on a home or other personal-use property.

Digital assets

Definitions

Digital assets: Assets such as cryptocurrencies and NFTs that are treated as property for tax purposes.

The Internal Revenue Service (IRS) has long taken the position that digital assets are treated the same as other property and are taxed when you receive them as payment for a transaction or when you sell them or trade them in a transaction. Digital assets received as payment for services are taxable as ordinary income at their fair market value on the date received.

However, issues have come up when digital assets are received for other purposes, such as through forks, staking, or mining - these are ordinary income when received (Schedule 1, or Schedule C if a business); a later sale of digital assets held as capital assets is reported on Form 8949 and carried to Schedule D. Digital assets are not viewed by the IRS as securities, and the wash sale rules do not apply to digital asset transactions. Digital assets are treated as capital assets along with other capital assets for tax loss harvesting.

Form 1099-DA, Digital asset proceeds from broker transactions, is an IRS information return used by digital asset brokers (such as cryptocurrency exchanges) to report proceeds from sales, exchanges, and other dispositions of digital assets such as cryptocurrencies and non-fungible tokens to both taxpayers and the IRS. Taxpayers must use the information on Form 1099-DA, along with their own detailed records, to properly calculate capital gains or losses and report them on Form 8949 and Schedule D of their Form 1040.

Capital assets & cost basis

Capital assets: nearly everything owned for personal use, pleasure, or investment (home, car, collectibles, stocks, bonds, digital currency)
Holding period determines tax rate:
- ≤1 year = short-term, taxed at ordinary income rates
- 1 year = long-term, taxed at favorable capital gain rates
Capital losses offset gains fully; net loss deductible against other income capped at $3,000/year ($1,500 MFS), excess carries forward
Cost basis = original purchase price, adjusted for splits, dividends, return of capital

Amount realized vs. amount recognized

Amount realized = total value received (cash + FMV of property + liabilities assumed)
Realized gain/loss = amount realized − adjusted basis − sale expenses
Amount recognized = taxable portion; usually equals realized gain/loss unless a rule (e.g., wash sale) defers/disallows it

Stock splits

Company increases share count by dividing existing shares (e.g., 2-for-1)
Total investment value unchanged; price per share decreases proportionally
New basis per share = original price ÷ split ratio; gain/loss calculated using adjusted per-share basis at sale

Wash sales

Occurs when security sold at a loss and substantially identical security repurchased within 30 days before/after sale (61-day window)
Loss is disallowed for tax purposes
Disallowed loss amount is added to the basis of the repurchased security
Applies to stocks, options, contracts, and other securities

Reporting & special property rules

Securities sales reported on Schedule D (Form 1040)
Active/regular traders may qualify as a trading business, deducting expenses on Schedule C
Personal item sales: gains taxable, losses not deductible
Inherited property: basis = FMV at date of death; automatically treated as long-term regardless of actual holding period
Gifted property dual basis rule:
- Gain: use donor’s adjusted basis
- Loss: use lower of donor’s basis or FMV at date of gift (prevents passing built-in losses)
Other special rules (installment sales, §121 home-sale exclusion, non-business bad debts) covered elsewhere in course

Options

Purchased option: cost is capital; sale = capital gain/loss; expiration = sale on expiration date (cost is a capital loss)
Exercised call: cost added to stock basis; exercised put: cost reduces amount realized
Option writer: premium not taxed when received; expired option = short-term capital gain
§1256 contracts (futures, nonequity options such as commodity and broad-based index options): marked to market at year-end; 60% long-term/40% short-term regardless of holding period; Form 6781

Mark-to-market (MTM) tax rules

Applies to traders electing Section 475(f) treatment
Treats assets as sold at fair market value on last business day of tax year
Business property sales reported on Form 4797:
- Net §1231 loss = ordinary loss
- Net §1231 gain (after depreciation recapture) = generally long-term capital gain

Foreclosures and abandonments

Foreclosure, repossession, or abandonment of property securing nonrecourse debt = sale; lender issues Form 1099-A (or only 1099-C if it also cancels $600+ of debt that year)
Nonrecourse debt: amount realized = full debt; no canceled debt income
Recourse debt: amount realized = lesser of debt or FMV; canceled excess = ordinary income
Loss deductible only on business/investment property, not a home

Digital assets

Treated as property for tax purposes, not securities
Taxable as ordinary income at FMV when received for services, forks, staking, or mining (reported on Schedule 1 or Schedule C)
Later sale of digital assets held as capital assets reported on Form 8949, then Schedule D
Wash sale rules do NOT apply to digital assets (useful for tax loss harvesting)
Form 1099-DA: broker-issued info return reporting digital asset sale/exchange proceeds to taxpayer and IRS; used with taxpayer records to complete Form 8949/Schedule D

Next | 3.3 Capital gains and income

Sales, losses, and special capital asset rules

Sales of capital assets and securities

Definitions

Capital assets: Almost everything owned and used for personal purposes, pleasure, or investment, such as a home, car, collectibles, stocks, bonds, and digital currency held for investment.
Cost basis (basis): The original purchase price of an investment, adjusted for factors like stock splits, dividends, and return of capital distributions.

Amount realized and amount recognized

Definitions

Amount realized: The total value received from a sale or disposition of an asset.
Amount recognized: The portion of a realized gain or loss that’s actually taxable - equal to the realized gain or loss unless a specific rule, such as the wash sale rule, defers or disallows part of it.

Example:

Chris sold a stock for $$10, 000$ ; his initial cost (basis) was $$2, 500$ . Chris’s amount realized is $$10, 000$ , and his realized gain is $$7, 500$ . The amount recognized is $$7, 500$ , the taxable portion, which in this case is the same as the realized gain.

Short-term capital gain example:

On January 29, 2025 Johnny purchased $100$ shares of XYZ stock, total $1, 000$ . On February 20, 2025, Johnny sold the same shares for $$1, 700$ . Johnny has realized and recognized a $$700$ short-term capital gain. Because he held the shares one year or less, the gain is taxed at his ordinary income tax rate, which depends on his total taxable income.

Short-term capital loss example:

On February 12, 2025, Mary purchased $100$ shares of XYZ stock at $$5$ a share, for a total of $$500$ . On April 25, 2025, the stock went down in price to $$2$ a share, so Mary sold all $100$ shares. Mary realizes and recognizes a short-term loss of $$300$ . Mary will recognize a loss at her own tax rate.

Long-term capital gain examples:

On February 18, 2024, Esmeralda went to a yard sale and bought a silver tea set for $$35$ . Then Esmeralda paid $$85$ to make a minor repair to the silver tea set before she decided to sell it. On May 13, 2025, Esmeralda sold the silver tea set for $$200$ . Esmeralda realized $$200$ , which was the amount she received from the sale, but her $$85$ repair was added to her $$35$ original basis, making her adjusted basis $$120$ . Therefore, Esmeralda recognizes (pays tax on) $$80$ . Esmeralda will have capital gains tax treatment on the sale of the silver tea set.

Long-term capital loss examples:

On March 7, 2023, April bought $400$ shares of XYZ Stock for $$2, 000$ . On April 24, 2025, she sold the same amount of shares for $$1, 800$ . April has realized and recognized a $$200$ long-term capital loss.

Bernard bought a house as an investment for $$38, 000$ and never lived in it. Five years later, he sold it for $$19, 000$ . Bernard has realized and recognized a $$19, 000$ long-term capital loss (had the house been his home, the loss would not be deductible); if he has no capital gains, he can deduct only $$3, 000$ of it against other income for the tax year and carries over the remaining amount.

Stock splits

Definitions

Stock split: When a company increases the number of its shares by dividing existing shares into multiple shares.

Scenario

Company: ABC Corp.
Pre-split price: $100 per share
Investor: Marcus owns $10$ shares of ABC Corp.
Split: ABC Corp. announces a 2-for-1 stock split.

Before the split, Marcus owned $10$ shares at $$100$ each, for a total value of $$1, 000$ ( $10$ shares $$100$ /share = $$1, 000$ ).

After the split, Marcus owns $20$ shares ( $10$ shares $\times 2 = 20$ shares). The price per share is now $$50$ (the original price divided by the split ratio: $$100$ / $2$ = $$50$ ). Marcus’s total value remains $$1, 000$ ( $20$ shares $\times $50$ /share $= $1, 000$ ).

On June 3, 2025, the fair market value of ABC stock rose to $$70$ a share, so Marcus sells $10$ shares of ABC for $$700$ . His amount realized is $10$ shares $\times $70$ /share $= $700$ ; his cost basis is $10$ shares $\times $50$ /share $= $500$ . Marcus will realize and recognize a gain of $$700 - $500 = $200$ .

Remember that Marcus still holds $10$ remaining shares of ABC stock, which he can sell at a later time. Marcus’s tax treatment will depend on the length of time that he has held the shares he had sold.

Wash sales

Definitions

Wash sale: A transaction where a security is sold at a loss and a substantially identical security is purchased within 30 days before or after the sale (a 61-day window), disallowing the loss for tax purposes.

Wash sale disallowed loss example:

On January 30, Curtis overheard a hot tip on a stock and decided to buy $1000$ shares of Dit Dit Corporation for $$5$ a share. On February 11, the stock had lost half its value; Curtis got impatient and sold all of his shares to cut his loss. The next day, Curtis repurchased $1000$ shares of Dit Dit Corporation for $$2, 400$ . Curtis will realize a $$2, 500$ loss but cannot recognize it for tax purposes, because he repurchased substantially identical stock the very next day - within the 30-day wash sale window. The $$2, 500$ disallowed loss is added to the basis of the repurchased shares.

Options

Options an employer grants as pay (nonstatutory options, incentive stock options and employee stock purchase plans) are taught in Earned and investment income.

Mark-to-market tax rules

Definitions

Mark-to-market (MTM): An accounting method that treats assets as sold at fair market value at the end of the tax year.

Foreclosures and abandonments (Form 1099-A)

Nonrecourse (not personally liable): the full debt, even if the property is worth less; there is no cancellation of debt income.
Recourse (personally liable): the smaller of the debt or the property’s fair market value. Canceled debt above that value is ordinary cancellation of debt income, separate from the gain or loss. Abandoning property that secures recourse debt produces no gain or loss until the foreclosure is completed.

Digital assets

Definitions

Digital assets: Assets such as cryptocurrencies and NFTs that are treated as property for tax purposes.

Key points

Capital assets & cost basis

Capital assets: nearly everything owned for personal use, pleasure, or investment (home, car, collectibles, stocks, bonds, digital currency)
Holding period determines tax rate:
- ≤1 year = short-term, taxed at ordinary income rates
- 1 year = long-term, taxed at favorable capital gain rates
Capital losses offset gains fully; net loss deductible against other income capped at $3,000/year ($1,500 MFS), excess carries forward
Cost basis = original purchase price, adjusted for splits, dividends, return of capital

Amount realized vs. amount recognized

Amount realized = total value received (cash + FMV of property + liabilities assumed)
Realized gain/loss = amount realized − adjusted basis − sale expenses
Amount recognized = taxable portion; usually equals realized gain/loss unless a rule (e.g., wash sale) defers/disallows it

Stock splits

Company increases share count by dividing existing shares (e.g., 2-for-1)
Total investment value unchanged; price per share decreases proportionally
New basis per share = original price ÷ split ratio; gain/loss calculated using adjusted per-share basis at sale

Wash sales

Occurs when security sold at a loss and substantially identical security repurchased within 30 days before/after sale (61-day window)
Loss is disallowed for tax purposes
Disallowed loss amount is added to the basis of the repurchased security
Applies to stocks, options, contracts, and other securities

Reporting & special property rules

Securities sales reported on Schedule D (Form 1040)
Active/regular traders may qualify as a trading business, deducting expenses on Schedule C
Personal item sales: gains taxable, losses not deductible
Inherited property: basis = FMV at date of death; automatically treated as long-term regardless of actual holding period
Gifted property dual basis rule:
- Gain: use donor’s adjusted basis
- Loss: use lower of donor’s basis or FMV at date of gift (prevents passing built-in losses)
Other special rules (installment sales, §121 home-sale exclusion, non-business bad debts) covered elsewhere in course

Options

Purchased option: cost is capital; sale = capital gain/loss; expiration = sale on expiration date (cost is a capital loss)
Exercised call: cost added to stock basis; exercised put: cost reduces amount realized
Option writer: premium not taxed when received; expired option = short-term capital gain
§1256 contracts (futures, nonequity options such as commodity and broad-based index options): marked to market at year-end; 60% long-term/40% short-term regardless of holding period; Form 6781

Mark-to-market (MTM) tax rules

Applies to traders electing Section 475(f) treatment
Treats assets as sold at fair market value on last business day of tax year
Business property sales reported on Form 4797:
- Net §1231 loss = ordinary loss
- Net §1231 gain (after depreciation recapture) = generally long-term capital gain

Foreclosures and abandonments

Foreclosure, repossession, or abandonment of property securing nonrecourse debt = sale; lender issues Form 1099-A (or only 1099-C if it also cancels $600+ of debt that year)
Nonrecourse debt: amount realized = full debt; no canceled debt income
Recourse debt: amount realized = lesser of debt or FMV; canceled excess = ordinary income
Loss deductible only on business/investment property, not a home

Digital assets

Treated as property for tax purposes, not securities
Taxable as ordinary income at FMV when received for services, forks, staking, or mining (reported on Schedule 1 or Schedule C)
Later sale of digital assets held as capital assets reported on Form 8949, then Schedule D
Wash sale rules do NOT apply to digital assets (useful for tax loss harvesting)
Form 1099-DA: broker-issued info return reporting digital asset sale/exchange proceeds to taxpayer and IRS; used with taxpayer records to complete Form 8949/Schedule D

Sales of capital assets and securities

Definitions

Capital assets: Almost everything owned and used for personal purposes, pleasure, or investment, such as a home, car, collectibles, stocks, bonds, and digital currency held for investment.
Cost basis (basis): The original purchase price of an investment, adjusted for factors like stock splits, dividends, and return of capital distributions.

Amount realized and amount recognized

Definitions

Amount realized: The total value received from a sale or disposition of an asset.
Amount recognized: The portion of a realized gain or loss that’s actually taxable - equal to the realized gain or loss unless a specific rule, such as the wash sale rule, defers or disallows part of it.

Example:

Chris sold a stock for $$10, 000$ ; his initial cost (basis) was $$2, 500$ . Chris’s amount realized is $$10, 000$ , and his realized gain is $$7, 500$ . The amount recognized is $$7, 500$ , the taxable portion, which in this case is the same as the realized gain.

Short-term capital gain example:

On January 29, 2025 Johnny purchased $100$ shares of XYZ stock, total $1, 000$ . On February 20, 2025, Johnny sold the same shares for $$1, 700$ . Johnny has realized and recognized a $$700$ short-term capital gain. Because he held the shares one year or less, the gain is taxed at his ordinary income tax rate, which depends on his total taxable income.

Short-term capital loss example:

On February 12, 2025, Mary purchased $100$ shares of XYZ stock at $$5$ a share, for a total of $$500$ . On April 25, 2025, the stock went down in price to $$2$ a share, so Mary sold all $100$ shares. Mary realizes and recognizes a short-term loss of $$300$ . Mary will recognize a loss at her own tax rate.

Long-term capital gain examples:

On February 18, 2024, Esmeralda went to a yard sale and bought a silver tea set for $$35$ . Then Esmeralda paid $$85$ to make a minor repair to the silver tea set before she decided to sell it. On May 13, 2025, Esmeralda sold the silver tea set for $$200$ . Esmeralda realized $$200$ , which was the amount she received from the sale, but her $$85$ repair was added to her $$35$ original basis, making her adjusted basis $$120$ . Therefore, Esmeralda recognizes (pays tax on) $$80$ . Esmeralda will have capital gains tax treatment on the sale of the silver tea set.

Long-term capital loss examples:

On March 7, 2023, April bought $400$ shares of XYZ Stock for $$2, 000$ . On April 24, 2025, she sold the same amount of shares for $$1, 800$ . April has realized and recognized a $$200$ long-term capital loss.

Bernard bought a house as an investment for $$38, 000$ and never lived in it. Five years later, he sold it for $$19, 000$ . Bernard has realized and recognized a $$19, 000$ long-term capital loss (had the house been his home, the loss would not be deductible); if he has no capital gains, he can deduct only $$3, 000$ of it against other income for the tax year and carries over the remaining amount.

Stock splits

Definitions

Stock split: When a company increases the number of its shares by dividing existing shares into multiple shares.

Scenario

Company: ABC Corp.
Pre-split price: $100 per share
Investor: Marcus owns $10$ shares of ABC Corp.
Split: ABC Corp. announces a 2-for-1 stock split.

Before the split, Marcus owned $10$ shares at $$100$ each, for a total value of $$1, 000$ ( $10$ shares $$100$ /share = $$1, 000$ ).

After the split, Marcus owns $20$ shares ( $10$ shares $\times 2 = 20$ shares). The price per share is now $$50$ (the original price divided by the split ratio: $$100$ / $2$ = $$50$ ). Marcus’s total value remains $$1, 000$ ( $20$ shares $\times $50$ /share $= $1, 000$ ).

On June 3, 2025, the fair market value of ABC stock rose to $$70$ a share, so Marcus sells $10$ shares of ABC for $$700$ . His amount realized is $10$ shares $\times $70$ /share $= $700$ ; his cost basis is $10$ shares $\times $50$ /share $= $500$ . Marcus will realize and recognize a gain of $$700 - $500 = $200$ .

Remember that Marcus still holds $10$ remaining shares of ABC stock, which he can sell at a later time. Marcus’s tax treatment will depend on the length of time that he has held the shares he had sold.

Wash sales

Definitions

Wash sale: A transaction where a security is sold at a loss and a substantially identical security is purchased within 30 days before or after the sale (a 61-day window), disallowing the loss for tax purposes.

Wash sale disallowed loss example:

On January 30, Curtis overheard a hot tip on a stock and decided to buy $1000$ shares of Dit Dit Corporation for $$5$ a share. On February 11, the stock had lost half its value; Curtis got impatient and sold all of his shares to cut his loss. The next day, Curtis repurchased $1000$ shares of Dit Dit Corporation for $$2, 400$ . Curtis will realize a $$2, 500$ loss but cannot recognize it for tax purposes, because he repurchased substantially identical stock the very next day - within the 30-day wash sale window. The $$2, 500$ disallowed loss is added to the basis of the repurchased shares.

Options

Options an employer grants as pay (nonstatutory options, incentive stock options and employee stock purchase plans) are taught in Earned and investment income.

Mark-to-market tax rules

Definitions

Mark-to-market (MTM): An accounting method that treats assets as sold at fair market value at the end of the tax year.

Foreclosures and abandonments (Form 1099-A)

Nonrecourse (not personally liable): the full debt, even if the property is worth less; there is no cancellation of debt income.
Recourse (personally liable): the smaller of the debt or the property’s fair market value. Canceled debt above that value is ordinary cancellation of debt income, separate from the gain or loss. Abandoning property that secures recourse debt produces no gain or loss until the foreclosure is completed.

Digital assets

Definitions

Digital assets: Assets such as cryptocurrencies and NFTs that are treated as property for tax purposes.