What Is a Sale or Trade? Words you may need to know (see Glossary): Equity option Futures contract hotel center IkskileMarked to market Nonequity option Options dealer Regulated futures contract Section 1256 contract Short sale This section explains what is a sale or trade. It also explainscertain transactions and events that are treated as sales or trades. A sale is generally a transfer of property for money or a mortgage,note, or other promise to pay money. A trade is a transfer of propertyfor other property or services, and may be taxed in the same way as asale. Sale and purchase.Ordinarily, a transaction is not a trade when you voluntarily sellproperty for cash and immediately buy similar property to replace it.The sale and purchase are two separate transactions. But seeLike-Kind Exchanges under Nontaxable Trades,later. Redemption of stock.A redemption of stock is treated as a sale or trade and is subjectto the capital gain or loss provisions unless the redemption is adividend or other distribution on stock. Dividend versus sale or trade.Whether a redemption is treated as a sale, trade, dividend, orother distribution depends on the circumstances in each case. Bothdirect and indirect ownership of stock will be considered. Theredemption is treated as a sale or trade of stock if: The redemption is not essentially equivalent to a dividend-- see Dividends and Other Corporate Distributions inchapter 1, There is a substantially disproportionate redemption ofstock, There is a complete redemption of all the stock of thecorporation owned by the shareholder, or The redemption is a distribution in partial liquidation of acorporation. Redemption or retirement of bonds.A redemption or retirement of bonds or notes at their maturitygenerally is treated as a sale or trade. See Stocks, stockrights, and bonds and Discounted Debt Instrumentsunder Capital or Ordinary Gain or Loss, later. In addition, a significant modification of a bond is treated as atrade of the original bond for a new bond. For details, see section1.1001-3 of the regulations. Surrender of stock.A surrender of stock by a dominant shareholder who retains controlof the corporation is treated as a contribution to capital rather thanas an immediate loss deductible from taxable income. The surrenderingshareholder must reallocate his or her basis in the surrendered sharesto the shares he or she retains. Trade of investment property for an annuity.The transfer of investment property to a corporation, trust, fund,foundation, or other organization, in exchange for a fixed annuitycontract that will make guaranteed annual payments to you for life, isa taxable trade. If the present value of the annuity is more than yourbasis in the property traded, you have a taxable gain in the year ofthe trade. Figure the present value of the annuity according tofactors used by commercial insurance companies issuing annuities. Transfer by inheritance.The transfer of property of a decedent to the executor oradministrator of the estate, or to the heirs or beneficiaries, is nota sale or other disposition. No taxable gain or deductible lossresults from the transfer. Termination of certain rights and obligations.The cancellation, lapse, expiration, or other termination of aright or obligation with respect to property that is a capital asset(or that would be a capital asset if you acquired it) is treated as asale. Any gain or loss is treated as a capital gain or loss. This rule does not apply to the retirement of a debt instrument.See Redemption or retirement of bonds, earlier. Worthless Securities Stocks, stock rights, and bonds (other than those held for sale bya securities dealer) that became worthless during the tax year aretreated as though they were sold on the last day of the tax year. Thisaffects whether your capital loss is long-term or short-term. SeeHolding Period, later. If you are a cash basis taxpayer and make payments on a negotiablepromissory note that you issued for stock that became worthless, youcan deduct these payments as losses in the years you actually make thepayments. Do not deduct them in the year the stock became worthless. How to report loss.Report worthless securities on line 1 or line 8 of Schedule D (Form1040), whichever applies. In columns (c) and (d), print "Worthless."Enter the amount of your loss in parentheses in column (f). Filing a claim for refund.If you do not claim a loss for a worthless security on youroriginal return for the year it becomes worthless, you can file aclaim for a credit or refund due to the loss. You must use Form 1040X,Amended U.S. Individual Income Tax Return, to amend yourreturn for the year the security became worthless. You must file itwithin 7 years from the date your original return for that year had tobe filed, or 2 years from the date you paid the tax, whichever islater. (Claims not due to worthless securities or bad debts generallymust be filed within 3 years from the date a return is filed, or 2years from the date the tax is paid.) For more information aboutfiling a claim, see Publication 556, Examination of Returns,Appeal Rights, and Claims for Refund. Constructive Salesof AppreciatedFinancial Positions You are treated as having made a constructive sale when you enterinto certain transactions involving an appreciated financial position(defined later) in stock, a partnership interest, or certain debtinstruments. You must recognize gain as if the position were disposedof at its fair market value on the date of the constructive sale. Thisgives you a new holding period for the position that begins on thedate of the constructive sale. Then, when you close the transaction,you reduce your gain (or increase your loss) by the gain recognized onthe constructive sale. Constructive sale.You are treated as having made a constructive sale of anappreciated financial position if you: Enter into a short sale of the same or substantiallyidentical property, Enter into an offsetting notional principal contractrelating to the same or substantially identical property, Enter into a futures or forward contract to deliver the sameor substantially identical property (including a forward contract thatprovides for cash settlement), or Acquire the same or substantially identical property (if theappreciated financial position is a short sale, an offsetting notionalprincipal contract, or a futures or forward contract). You are also treated as having made a constructive sale of anappreciated financial position if a person related to you enters intoa transaction described above with a view toward avoiding theconstructive sale treatment. For this purpose, a related person is anyrelated party described under Related Party Transactions,later in this chapter. Exception for nonmarketable securities.A contract for sale of any stock, debt instrument, or partnershipinterest that is not a marketable security is not a constructive saleif it settles within 1 year of the date you enter into it. Exception for certain closed transactions.Do not treat a transaction as a constructive sale if all of thefollowing are true. You closed the transaction before the end of the 30th dayafter the end of your tax year. You held the appreciated financial position throughout the60-day period beginning on the date you closed the transaction. Your risk of loss was not reduced at any time during that60-day period by holding certain other positions. If a closed transaction is reestablished in a substantially similarposition during the 60-day period beginning on the date the firsttransaction was closed, this exception still applies if thereestablished position is closed before the end of the 30th day afterthe end of your tax year in which the first transaction was closedand, after that closing, (2) and (3) above are true. Appreciated financial position.This is any interest in stock, a partnership interest, or a debtinstrument (including a futures or forward contract, a short sale, oran option) if disposing of the interest would result in a gain. Exceptions.An appreciated financial position does not include the following. Any position from which all of the appreciation is accountedfor under marked to market rules, including section 1256 contracts(described later under Section 1256 Contracts Marked toMarket). Any position in a debt instrument if: The position unconditionally entitles the holder to receivea specified principal amount, The interest payments (or other similar amounts) withrespect to the position are payable at a fixed rate or a variable ratedescribed in section 1.860G-1(a)(3) of the regulations,and The position is not convertible, either directly orindirectly, into stock of the issuer (or any related person). Any hedge with respect to a position described in(2). Certain trust instruments treated as stock.For the constructive sale rules, an interest in an actively tradedtrust is treated as stock unless substantially all of the value of theproperty held by the trust is debt that qualifies for the exception tothe definition of an appreciated financial position (explained in (2)above). Sale of appreciated financial position.A transaction treated as a constructive sale of an appreciatedfinancial position is not treated as a constructive sale of any otherappreciated financial position, as long as you continue to hold theoriginal position. However, if you hold another appreciated financialposition and dispose of the original position before closing thetransaction that resulted in the constructive sale, you are treated asif, at the same time, you constructively sold the other appreciatedfinancial position. Transitional rules.A special rule may apply if you entered into a transaction beforeJune 9, 1997, that was a constructive sale of an appreciated financialposition. Under this rule, you do not take either the position or thetransaction into account to determine whether any other constructivesale has occurred after June 8, 1997. This rule applies only if,before September 4, 1997, you clearly identified the transaction andthe position in your records as offsetting. This rule does not applyas of the date you close the transaction or stop holding the position. Transitional rule for decedents.A special rule may apply if there was a constructive sale beforeJune 9, 1997, of an appreciated financial position held by a decedentdying after June 8, 1997. Under this rule, treat the position and thetransaction that resulted in the constructive sale as propertyconstituting rights to receive an item of income in respect of adecedent. However, gain on the position that accrues after thetransaction is closed is not treated as income in respect of adecedent. This rule applies only if both the following requirements are met. The transaction resulting in the constructive sale remainsopen (with respect to the decedent or any related person)-- For at least 2 years after the date of the transaction,and At any time during the 3-year period ending on the date ofthe decedent's death. The transaction was not closed before September 5,1997. Section 1256 ContractsMarked to Market If you hold a section 1256 contract at the end of the tax year, yougenerally must treat it as sold at its fair market value on the lastbusiness day of the tax year. Section 1256 Contract A section 1256 contract is any: Regulated futures contract, Foreign currency contract, Nonequity option, or Dealer equity option. Regulated futures contract.This is a contract that: Provides that amounts that must be deposited to, or can bewithdrawn from, your margin account depend on daily market conditions(a system of marking to market), and Is traded on, or subject to the rules of, a qualified boardof exchange. A qualified board of exchange is a domestic board of tradedesignated as a contract market by the Commodity Futures TradingCommission, any board of trade or exchange approved by the Secretaryof the Treasury, or a national securities exchange registered with theSecurities and Exchange Commission. Foreign currency contract.This is a contract that: Requires delivery of a foreign currency that has positionstraded through regulated futures contracts (or settlement of whichdepends on the value of that type of foreign currency), Is traded in the interbank market, and Is entered into at arm's length at a price determined byreference to the price in the interbank market. Bank forward contracts with maturity dates that are longer than thematurities ordinarily available for regulated futures contracts areconsidered to meet the definition of a foreign currency contract ifthe above three conditions are satisfied. Special rules apply to certain foreign currency transactions. Thesetransactions may result in ordinary gain or loss treatment. Fordetails, see Internal Revenue Code section 988 and regulationssections 1.988-1(a)(7) and 1.988-3. Nonequity option.This is any listed option (defined below) that is not an equityoption. Nonequity options include debt options, commodity futuresoptions, currency options, and broad-based stock index options. Abroad-based stock index is based upon the value of a group ofdiversified stocks or securities (such as the Standard and Poor's 500index). Warrants based on a stock index that are economically,substantially identical in all material respects to options based on astock index are treated as options based on a stock index. Cash-settled options.Cash-settled options based on a stock index and either traded on orsubject to the rules of a qualified board of exchange are nonequityoptions if the Securities and Exchange Commission (SEC) determinesthat the stock index is broad based. This rule does not apply to options established by November 10,1994, or before the SEC determines that the stock index is broadbased. Listed option.This is any option that is traded on, or subject to the rules of, aqualified board or exchange (as discussed earlier under Regulatedfutures contract). A listed option, however, does not include anoption that is a right to acquire stock from the issuer. Dealer equity option.hotel rooms BrightonThis is any listed option that, for an options dealer: Is an equity option, Is bought or granted by that dealer in the normal course ofthe dealer's business activity of dealing in options, and Is listed on the qualified board of exchange where thatdealer is registered. An options dealer is any person registered with anappropriate national securities exchange as a market maker orspecialist in listed options. Equity option.This is any option: To buy or sell stock, or That is valued directly or indirectly by reference to anystock, group of stocks, or stock index. Equity options include options on certain narrow-based stockindexes, but exclude options on broad-based stock indexes and optionson stock index futures. An equity option, however, does not include an option for any groupof stocks or stock index if: The Commodities Futures Trading Commission has designated acontract market for a contract based on that group or index, and thatdesignation is in effect, or The Secretary of the Treasury determines that the optionmeets the legal requirements for such a designation. Marked to Market Rules A section 1256 contract that you hold at the end of the tax yearwill generally be treated as sold at its fair market value on the lastbusiness day of the tax year, and you must recognize any gain or lossthat results. That gain or loss is taken into account in figuring yourgain or loss when you later dispose of the contract, as shown in theexample under 60/40 rule, below. Hedging exception.The marked to market rules do not apply to hedging transactions.See Hedging Transactions, later. 60/40 rule.Under the marked to market system, 60% of your capital gain or losswill be treated as a long-term capital gain or loss, and 40% will betreated as a short-term capital gain or loss. This is true regardlessof how long you actually held the property. Example.On June 23, 1999, you bought a regulated futures contract for$50,000. On December 31, 1999 (the last business day of your taxyear), the fair market value of the contract was $57,000. You have a$7,000 gain recognized on your 1999 tax return, treated as 60%long-term and 40% short-term capital gain. On February 2, 2000, you sold the contract for $56,000. Because youalready recognized a $7,000 gain on your 1999 return, you recognize a$1,000 loss ($57,000 - $56,000) on your 2000 tax return, treatedas 60% long-term and 40% short-term capital loss. Limited partners or entrepreneurs.The 60/40 rule does not apply to dealer equity options that resultin capital gain or loss allocable to limited partners or limitedentrepreneurs (defined later under Hedging Transactions).Instead, these persons should treat all these gains or losses as shortterm under the marked to market system. Terminations and transfers.The marked to market rules also apply if your obligation or rightsunder section 1256 contracts are terminated or transferred during thetax year. In this case, use the fair market value of each section 1256contract at the time of termination or transfer to determine the gainor loss. Terminations or transfers may result from any offsetting,delivery, exercise, assignment, or lapse of your obligation or rightsunder section 1256 contracts. Loss carryback election.An individual or partnership having a net section 1256 contractsloss (defined later) for 2000 can elect to carry this loss back 3years, instead of carrying it over to the next year. See How ToReport, keno fur geld spielenlater, for information about reporting this election onyour return. The loss carried back to any year under this election cannot bemore than the net section 1256 contracts gain in that year. Inaddition, the amount of loss carried back to an earlier tax yearcannot increase or produce a net operating loss for that year. The loss is carried to the earliest carryback year first, and anyunabsorbed loss amount can then be carried to each of the next 2 taxyears. In each carryback year, treat 60% of the carryback amount as along-term capital loss and 40% as a short-term capital loss fromsection 1256 contracts. TaxTip: Do not treat any part of a net section 1256 contracts loss carriedto 1997 as a 28% rate gain or loss. (For 1997, certain long-termcapital gains and losses from property held 18 months or less weretreated as 28% rate gains and losses (discussed under ReportingCapital Gains and Losses)). If only a portion of the net section 1256 contracts loss isabsorbed by carrying the loss back, the unabsorbed portion can becarried forward, under the capital loss carryover rules, to the yearfollowing the loss. (See Capital Losses underReporting Capital Gains and Losses, later.) Figure yourcapital loss carryover as if, for the loss year, you had an additionalshort-term capital gain of 40% of the amount of net section 1256contracts loss absorbed in the carryback years and an additionallong-term capital gain of 60% of the absorbed loss. In the carryoveryear, treat any capital loss carryover from losses on section 1256contracts as if it were a loss from section 1256 contracts for thatyear. Net section 1256 contracts loss.This loss is the lesser of: The net capital loss for your tax year determined by takinginto account only the gains and losses from section 1256 contracts, or The capital loss carryover to the next tax year determinedwithout this election. Net section 1256 contracts gain.This gain is the lesser of: The capital gain net income for the carryback yeardetermined by taking into account only gains and losses from section1256 contracts, or The capital gain net income for that year. Figure your net section 1256 contracts gain for any carrybackyear without regard to the net section 1256 contracts loss for theloss year or any later tax year. Traders in section 1256 contracts.Gain or loss from the trading of section 1256 contracts is capitalgain or loss subject to the marked to market rules. However, this doesnot apply to contracts held for purposes of hedging property if anyloss from the property would be an ordinary loss. Treatment of underlying property. The determination of whether an individual's gain or loss from anyproperty is ordinary or capital gain or loss is made without regard tothe fact that the individual is actively engaged in dealing in ortrading section 1256 contracts related to that property. How To Report If you disposed of regulated futures or foreign currency contractsin 2000 (or had unrealized profit or loss on these contracts that wereopen at the end of 1999 or 2000), you should receive Form1099-B, or an equivalent statement, from your broker. Form 6781.Use Part I of Form 6781, Gains and Losses From Section 1256Contracts and Straddles, to report your gains and losses fromall section 1256 contracts that are open at the end of the year orthat were closed out during the year. This includes the amount shownin box 9 of Form 1099-B. Then enter the net amount of thesegains and losses on Schedule D (Form 1040). Include a copy of Form6781 with your income tax return. If the Form 1099-B you receive includes a straddle or hedgingtransaction, defined later, it may be necessary to show certainadjustments on Form 6781. Follow the Form 6781 instructions forcompleting Part I. Loss carryback election.To carry back your loss under the election procedures describedearlier, file Form 1040X or appropriate amended return for the year towhich you are carrying the loss with an amended Form 6781 attached.Follow the instructions for completing Form 6781 for the loss year tomake this election. Hedging Transactions The marked to market rules, described earlier, do not apply tohedging transactions. A transaction is a hedging transaction if bothof the following conditions are met. You entered into the transaction in the normal course ofyour trade or business primarily to manage the risk of: Price changes or currency fluctuations on ordinary propertyyou hold (or will hold), or Interest rate or price changes, or currency fluctuations, onyour current or future borrowings or ordinary obligations. You clearly identified the transaction as being a hedgingtransaction before the close of the day on which you entered intoit. This hedging transaction exception does not apply totransactions entered into by or for any syndicate. A syndicateis a partnership, S corporation, or other entity (other than a regularcorporation) that allocates more than 35% of its losses to limitedpartners or limited entrepreneurs. A limited entrepreneuris a person who has an interest in an enterprise (but not as a limitedpartner) and who does not actively participate in its management.However, an interest is not considered held by a limited partner orentrepreneur if the interest holder actively participates (or did sofor at least 5 full years) in the management of the entity, or is thespouse, child (including a legally adopted child), grandchild, orparent of an individual who actively participates in the management ofthe entity. Hedging loss limit.If you are a limited partner or entrepreneur in a syndicate, theamount of a hedging loss you can claim is limited. A "hedging loss"is the amount by which the allowable deductions in a tax year thatresulted from a hedging transaction (determined without regard to thelimit) are more than the income received or accrued during the taxyear from this transaction. Any hedging loss that is allocated to you for the tax year islimited to your taxable income for that year from the trade orbusiness in which the hedging transaction occurred. Ignore any hedgingtransaction items in determining this taxable income. If you have ahedging loss that is disallowed because of this limit, you can carryit over to the next tax year as a deduction resulting from a hedgingtransaction. If the hedging transaction relates to property other than stock orsecurities, the limit on hedging losses applies if the limited partneror entrepreneur is an individual. The limit on hedging losses does not apply to any hedging loss tothe extent that it is more than all your unrecognized gains fromhedging transactions at the end of the tax year that are from thetrade or business in which the hedging transaction occurred. The term"unrecognized gain" has the same meaning as defined underStraddles, later. Sale of property used in a hedge.Once you identify personal property as being part of a hedgingtransaction, you must treat gain from its sale or exchange as ordinaryincome, not capital gain. Self-Employment Income Gains and losses derived in the ordinary course of a commodity oroption dealer's trading in section 1256 contracts and property relatedto these contracts are included in net earnings from self-employment.In addition, the rules relating to contributions to self-employmentretirement plans apply. For information on retirement plancontributions, see chapter 3 of Publication 535, BusinessExpenses, Publication 560, Porto hotelsRetirement Plans for SmallBusiness, and Publication 590, Individual RetirementArrangements (IRAs).