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Chapter 15. Sale of Property

Important Reminder

Holding period. The holding period for a long-term gain or loss is more than
one year, and the holding period for a short-term gain or loss is one year
or less.

Introduction

This chapter discusses the tax consequences of selling or trading investment
property. It explains:

∙  What is a sale or trade,

∙  When you have a nontaxable trade,

∙  What to do with a related party transaction,

∙  Whether the property you sell is a capital asset or a noncapital asset,

∙  Whether you have a capital or ordinary gain or loss from the sale of
   property, and

∙  How to determine your holding period.

Sales not discussed in this publication. Certain sales or trades of
property are discussed in other IRS publications. They include, for example,
installment sales, covered in Publication 537, Installment Sales, and
transfers of property at death, covered in Publication 559, Tax Information
for Survivors, Executors, and Administrators.

Publication 544, Sales and Other Dispositions of Assets, provides information
about various types of transactions involving business property, including
dispositions of assets used in a trade or business or for the production of
income.

Publication 550, Investment Income and Expenses, provides more detailed
discussion about sales and trades of investment property. Publication 550
includes information about the rules covering bad debts, straddles, section
1256 contracts, puts and calls, commodity futures, short sales, and wash
sales. It also discusses investment-related expenses.

Publication 925, Passive Activity and At-Risk Rules, discusses the rules that
limit losses and credits from passive activities as well as the rules that
apply to the disposition of an interest in a passive activity.

If you sell your home, different tax rules apply. These rules are discussed
in Chapter 16.

Related publications and forms.

This chapter refers to several publications and forms that you may need.
The list of forms does not include Forms 1040, 1040A, and 1040EZ. For more
information, you may want to order any of the following:

    Publication 504, Tax Information for Divorced or Separated Individuals

    Publication 550, Investment Income and Expenses

    Publication 564, Mutual Fund Distributions

    Publication 925, Passive Activity and At-Risk Rules

    Schedule D (Form 1040), Capital Gains and Losses

    Form 4684, Casualties and Thefts

    Form 8824, Like-Kind Exchanges

Sales and Trades

Sales and trades (or exchanges) of assets generally result in taxable gains
or deductible losses, although some trades of property are nontaxable.

Form 1099─B. If you sold property such as securities, commodities, bonds,
etc., through a broker, you should receive Form 1099─B, Proceeds From Broker
and Barter Exchange Transactions, or an equivalent statement from the broker.
You should receive the statement by January 31, 1993, showing the gross
proceeds from sales during 1992. The Internal Revenue Service (IRS) will
also get a copy of Form 1099─B from the broker.

If you receive a Form 1099─B or equivalent statement, you must complete
Schedule D of Form 1040.

Unstated interest and imputed principal rules for sales or exchanges. For
information about the unstated interest rules applicable to certain payments
received on account of a seller-financed sale or exchange of property, and
about the imputed principal rules applicable to any debt instrument issued
on account of such transactions, see Publication 537.

What is a Sale or Trade?

A sale is generally a transfer of property for money only or for a promise to
pay money, such as a mortgage or note. A trade is a transfer of property in
return for other property or services and may be taxed in the same way as a
sale.

Sale and purchase. Ordinarily, a transaction is not a trade when you
voluntarily sell property for cash and immediately buy similar property
to replace it. Such a sale and purchase are two separate transactions.

Redemption of stock. A redemption of stock is treated as a sale or trade and
is subject to the capital gain or loss provisions unless the redemption is a
dividend or other distribution on stock.

Dividend vs. sale or trade. Whether a redemption is treated as a sale, trade,
dividend, or other distribution depends on the circumstances in each case.
Both direct and indirect ownership of stock will be considered. The
redemption is treated as a sale or trade of stock if:

1)  The redemption is not essentially equivalent to a dividend (see
    Chapter 9),

2)  There is a substantially disproportionate redemption of stock,

3)  There is a complete redemption of all the stock of the corporation owned
    by the shareholder, or

4)  The redemption is a distribution in partial liquidation of a corporation.

Redemption or retirement of bonds. A redemption or retirement of bonds or
notes at their maturity is a sale or trade that you must report on Schedule
D (Form 1040) whether or not you realize gain or loss on the transaction.

However, if the issuer has merely extended the maturity date of its notes,
during which period some of the noteholders have agreed not to redeem their
notes until all the other notes are retired or their retirement is provided
for, neither a trade nor a closed or completed transaction has occurred.
Under these circumstances, you do not figure gain or loss.

Surrender of stock. A surrender of stock by a dominant shareholder, who
retains control of the corporation, is treated as a contribution to capital
rather than as an immediate loss deductible from taxable income. The
surrendering shareholder must reallocate his or her basis in the surrendered
shares to the shares he or she retains.

How to Figure a Gain or Loss

You figure gain or loss on a sale or trade of property by comparing the
amount you realize with the adjusted basis of the property.

Gain is the amount you realize from a sale or trade minus the adjusted
basis of the property you transfer.

Loss is the adjusted basis of the property minus the amount you realize.

The adjusted basis of property is your original cost or other original
basis properly adjusted (increased or decreased) for items such as purchase
commissions and legal fees. In determining gain or loss, the cost of
transferring property to the new owner, such as selling expenses, is added
to the adjusted basis of the property. See Chapter 14 for more information
about determining the adjusted basis of property.

Amount realized. The amount you realize from a sale or trade of property is
everything you receive for the property. This includes the money you receive
plus the fair market value of all property or services you receive.

Fair market value. Fair market value is the price at which the property would
change hands between a buyer and a seller, neither being forced to buy or
sell and both having reasonable knowledge of all the relevant facts.

The fair market value of notes or other evidence of indebtedness you receive
as a part of the sale price is usually the best amount you can get from
selling them to, or discounting them with, a bank or other buyer of such
debt instruments.

An indebtedness against the property, or against you, that is paid off as a
part of the transaction, or that is assumed by the buyer, must be included
in the amount realized. This is true even if neither you nor the buyer is
personally liable for the debt. For example, if you sell or trade property
that is subject to a nonrecourse loan, the amount you realize includes the
full amount of the note assumed by the buyer even though the amount of the
note exceeds the fair market value of the property.

Payment of cash. If you trade property for other property and in addition
pay cash, the amount you realize is the fair market value of the property you
receive. Determine your gain or loss by subtracting your adjusted basis (the
cash you pay plus the adjusted basis of the property you traded in) from the
amount you realize.

Example 1. You sell stock that you had pledged as security for a bank loan of
$8,000. Your basis in the stock is $6,000. The buyer pays off your bank loan
and pays you $20,000 in cash. The amount realized is $28,000 ($20,000 +
$8,000). Your gain is $22,000 ($28,000 - $6,000).

Example 2. You trade A Company stock with an adjusted basis of $7,000 for
B Company stock with a fair market value of $10,000, which is your amount
realized. Your gain is $3,000 ($10,000 - $7,000). If you also receive a note
for $6,000 that has a discount value of $4,000, your gain is $7,000 (($10,000
+ $4,000) - $7,000).

No gain or loss. You may be required to use a basis for figuring gain
different from that used for figuring loss. In this case, you may not have a
gain or loss. See Other Basis in Chapter 14. In these situations, if you use
the basis for determining a gain and figure a loss, and then use the basis for
determining a loss and figure a gain, you will have neither a gain nor a loss.

Example. You receive a gift of investment property having an adjusted basis
of $10,000 at the time of the gift. The fair market value at the time of the
gift is $9,000. You later sell the property for $9,500. You have neither gain
nor loss. Your basis for figuring gain is $10,000, and $10,000 minus $9,500
results in a $500 loss. Your basis for figuring loss is $9,000, and $9,500
minus $9,000 results in a $500 gain.

Nontaxable Trades

Certain trades or exchanges are nontaxable. This means that any gain from
the exchange is not taxed, and any loss cannot be deducted. In other words,
even though you may realize a gain or loss on the exchange, it will not be
recognized for tax purposes. The property you get carries over the basis of
the property you had before the exchange.

If you traded business property or depreciable investment property, see
Publication 544.

Like-kind exchanges. If you traded business or investment property for other
business or investment property of a like kind, you must postpone tax on the
gain or postpone deducting the loss until you sell or dispose of the property
you receive. To be nontaxable, a like-kind exchange must meet all six of the
following conditions:

1)  The property must be business or investment property. You must hold both
    the property you trade and the property you receive for business or
    investment purposes. Neither property may be used for personal purposes,
    such as your home or family car.

2)  The property must not be property held for sale. The property you trade
    and the property you receive must not be property you sell to customers,
    such as merchandise. It must be property held for investment or property
    held for productive use in your trade or business.

3)  There must be an exchange of like-kind property. The exchange of real
    estate for real estate and the exchange of personal property for similar
    personal property are exchanges of like-kind property. The trade of an
    apartment house for a store building or a panel truck for a pickup truck
    are like-kind exchanges. The exchange of a piece of machinery for a store
    building is not a like-kind exchange.

4)  The property must be tangible property. These rules and benefits do
    not apply to exchanges of stocks, bonds, notes, choses in action,
    certificates of trust or beneficial interest, or other securities
    or evidence of indebtedness or interest, including the exchange of
    partnership interests. However, you can have a nontaxable exchange
    of corporate stocks, as discussed later under Corporate stocks.

5)  The property must meet the identification requirement. The property to
    be received must be identified on or before the day that is 45 days
    after the date of transfer of the property given up in the exchange.

6)  The exchange must meet the completed transaction requirement. The
    property must be received on or before the earlier of:

    a)  The 180th day after the date on which you transfer the property
        given up in the transfer, or

    b)  The due date, including extensions, for your tax return for the
        year in which the transfer of the property given up occurs.

Partially nontaxable exchange. If, in addition to like-kind property, you
receive cash or nonlike-kind property, and the above conditions are met, you
have a partially nontaxable trade. You are taxed on the gain you realize, but
only to the extent of the cash and the fair market value of the nonlike-kind
property you receive. You cannot deduct a loss.

If you pay money in addition to transferring property in exchange for
like-kind property, you have no taxable gain or deductible loss.

If you give up nonlike-kind property in addition to the like-kind property,
you must recognize gain or loss only on the nonlike-kind property you give
up. The gain or loss is the difference between the adjusted basis of the
nonlike-kind property and its fair market value. See Chapter 1 of Publication
544 for more information about partially nontaxable exchanges.

To figure the basis of the property received, see Nontaxable Exchanges in
Chapter 14.

How to report. You must report the exchange of business or investment
like-kind property on Schedule D of Form 1040 (or Form 4797, Sales of
Business Property, whichever applies) and on Form 8824, Like-Kind Exchanges.

For exchanges reported on Schedule D, write "From Form 8824" in column (a).
Skip columns (b) through (e), and enter the gain or loss from Form 8824, if
any, in column (f) or (g). (See Chapter 17 to determine whether to use line
1a, 1d, 8a, or 8d.) If one or more exchanges involved a related party, write
"Related Party Like-Kind Exchange" at the top of Schedule D.

To compute any partial gains or losses and for more information on like-kind
exchanges, see the instructions for Form 8824. For more information on how
to report the sale of business property, see Publication 544.

Transfers of property between spouses or incident to divorce. Generally, no
gain or loss is recognized on a transfer of property from an individual to
(or in trust for the benefit of) a spouse, or a former spouse if incident to
a divorce. This nonrecognition rule does not apply if the recipient-spouse
or former spouse is a nonresident alien. The rule also does not apply to a
transfer in trust to the extent the adjusted basis of the property is less
than the amount of the liabilities assumed and liabilities on the property.

Any transfer of property to a spouse or former spouse on which gain or loss
is not recognized is treated by the transferee as acquired by gift and is not
considered as a sale or exchange. The transferee's basis in the property will
be the same as the adjusted basis of the transferor immediately before the
transfer. This carryover basis rule applies whether the adjusted basis of the
transferred property is less than, equal to, or greater than its fair market
value at the time of transfer. This rule applies for purposes of determining
loss as well as gain. Any gain recognized on a transfer in trust increases the
basis.

A transfer of property is incident to a divorce if the transfer occurs within
one year after the date on which the marriage ends, or if the transfer is
related to the ending of the marriage.

For more information, see Publication 504, Tax Information for Divorced or
Separated Individuals.

Corporate stocks. The following trades of corporate stocks generally do not
result in a taxable gain or a deductible loss.

Stock for stock of the same corporation. You can exchange common stock for
common stock or preferred stock for preferred stock in the same corporation
without having a recognized gain or loss. This is true for a trade between
two persons as well as a trade between a stockholder and a corporation.

In some instances, you can trade common stock for preferred stock, preferred
stock for common stock, or stock in one corporation for stock in another
corporation without having a recognized gain or loss. These trades must be
part of mergers, recapitalizations, transfers to controlled corporations,
bankruptcies, corporate divisions, corporate acquisitions, or other
corporate reorganizations.

Convertible stocks and bonds. You will not have a recognized gain or loss if
you convert bonds into stock or preferred stock into common stock of the same
corporation according to a conversion privilege in the terms of the bond or
the preferred-stock certificate, except where gain is specifically required
to be recognized.

Property for stock of a controlled corporation. If you transfer property to a
corporation solely in exchange for stock in that corporation, and immediately
after the trade you are in control of the corporation, you ordinarily will not
recognize a gain or loss. This rule applies both to individuals and to groups
who transfer property to a corporation. It does not apply if the corporation
is an investment company.

However, if you had a gain from the disposition of depreciable property from
this transaction, you may be taxed on part of the gain. See Dispositions of
Depreciable Property in Publication 544 for more information.

For this purpose, to be in control of a corporation, you or your group of
transferors must own, immediately after the exchange, at least 80% of the
total combined voting power of all classes of stock entitled to vote, and at
least 80% of the outstanding shares of each class of nonvoting stock of the
corporation. See Chapter 4 of Publication 544 for information about other
exchanges for corporate stocks.

If this provision applies to you, you must attach to your return a complete
statement of all facts pertinent to the exchange.

For more information on trades of stock, see Nontaxable Trades in Publication
550.

Insurance policies and annuities. You will not have a recognized gain or
loss if you trade:

1)  A life insurance contract for another life insurance contract or for an
    endowment or an annuity contract,

2)  An endowment contract for an annuity contract, or for another endowment
    contract that provides for regular payments beginning at a date not
    later than the beginning date under the old contract, or

3)  An annuity contract for another annuity contract.

The insured or annuitant must stay the same as under the original contract.
Exchanges of contracts not included in this list, such as an annuity contract
for an endowment contract, or an annuity or endowment contract for a life
insurance contract, are taxable.

U.S. Treasury notes or bonds. You can trade certain issues of U.S. Treasury
obligations for other issues, designated by the Secretary of the Treasury,
with no gain or loss recognized on the trade. See U.S. Treasury Notes or Bonds
under Nontaxable Trades in Publication 550 for information about the tax
treatment of income from these investments. For other information on
Treasury notes or bonds, write to:

                     Bureau of the Public Debt
                     U.S. Department of Treasury
                     Washington, D.C. 20239─1000

Related Party Transactions

Special rules apply to the sale or trade of property between related parties.

Like-kind exchanges. Generally, if you trade business or investment property
for other business or investment property of a like kind, no gain or loss
is recognized. See Like-kind exchanges discussed earlier under Nontaxable
Trades.

This rule applies to exchanges of property between related parties, defined
next under Loss on sale or trade of property. However, if either related party
disposes of the like-kind property within 2 years after the exchange, the gain
or loss on the exchange must be recognized. Each related person must report
any gain or loss not recognized on the original exchange on the tax return
filed for the year in which the later disposition occurred. This rule applies
to all transfers after July 10, 1989, except those made under binding
contracts in effect on that date and up to the time of transfer.

These rules generally do not apply to:

    Dispositions due to the death of either related person,

    Involuntary conversions (see Chapter 1 of Publication 544), or

    Exchanges or dispositions whose main purpose is not the avoidance of
    federal income tax.

The 2─year period does not include the period during which the holder's
risk of loss is substantially diminished by:

    The holding of a put on the property,

    The holding by another person of a right to acquire the property, or

    A short sale or any other transaction.

Loss on sale or trade of property. You cannot deduct a loss on the sale or
trade of property, other than a distribution in complete liquidation of a
corporation, if the transaction is directly or indirectly between you and
the following related parties:

1)  Members of your family - this includes only your brothers and sisters,
    half-brothers and half-sisters, spouse, ancestors (parents, grandparents,
    etc.), and lineal descendants (children, grandchildren, etc.).

2)  A corporation in which you directly or indirectly own more than 50% in
    value of the outstanding stock (see Constructive ownership of stock,
    later).

3)  A tax-exempt charitable or educational organization that is directly
    or indirectly controlled, in any manner or by any method, by you or
    by a member of your family, whether or not this control is legally
    enforceable.

In addition, a loss on the sale or trade of property is not deductible if the
transaction is directly or indirectly between the following related parties:

1)  A grantor and fiduciary, and the fiduciary and beneficiary, of any trust,

2)  Fiduciaries of two different trusts, and the fiduciary and beneficiary
    of two different trusts, if the same person is the grantor of both trusts,

3)  A trust fiduciary and a corporation of which more than 50% in value of
    the outstanding stock is directly or indirectly owned, by or for the
    trust, or by or for the grantor of the trust,

4)  A corporation and a partnership if the same persons own more than 50% in
    value of the outstanding stock of the corporation and more than 50% of
    the capital interest, or the profits interest, in the partnership,

5)  Two S corporations if the same persons own more than 50% in value of
    the outstanding stock of each corporation,

6)  Two corporations, one of which is an S corporation, if the same persons
    own more than 50% in value of the outstanding stock of each corporation,
    or

7)  Two corporations that are members of the same controlled group (under
    certain conditions, however, such losses are not disallowed but must be
    deferred).

If you sell or trade to a related party a number of blocks of stock or pieces
of property in a lump sum, you must figure the gain or loss separately for
each block of stock or piece of property. The gain on each item may be
taxable. However, you cannot deduct the loss on any item. Also, you cannot
reduce gains from the sales of any of these items by losses on the sales
of any of the other items.

Indirect transactions include sales through a stock exchange. You cannot
deduct your loss on the sale of stock through your broker if, for example,
under a prearranged plan a related person or entity buys the same stock
that you had owned.

Constructive ownership of stock. In determining whether a person directly or
indirectly owns any of the outstanding stock of a corporation, the following
rules apply.

Rule 1. Stock directly or indirectly owned, by or for a corporation,
partnership, estate, or trust is considered owned proportionately by or
for its shareholders, partners, or beneficiaries.

Rule 2. An individual is considered to own the stock that is directly or
indirectly owned by or for his or her family. Family includes only brothers
and sisters, half-brothers and half-sisters, spouse, ancestors, and lineal
descendants.

Rule 3. An individual owning, other than by applying rule 2, any stock in a
corporation is considered to own the stock that is directly or indirectly
owned by or for his or her partner.

Rule 4. Stock constructively owned by a person under rule 1 is treated as
actually owned by that person, for applying rules 1, 2, or 3. But stock
constructively owned by an individual under rule 2 or 3 is not treated as
owned by that individual for again applying either rule 2 or 3 to make
another person the constructive owner of the stock.

Property received from a related party. If you sell or trade at a gain
property that you acquired from a related party, you recognize the gain
only to the extent it is more than the loss previously disallowed to the
transferor. This rule applies only if you are the original transferee and you
acquired the property by purchase or exchange. This rule does not apply if the
transferor's loss was disallowed because of the wash sale rules, described
in Publication 550 under Wash Sales.

Example 1. Your brother sells you stock with a cost basis of $10,000 for
$7,600. Your brother cannot deduct the loss of $2,400. Later, you sell the
same stock to an unrelated party for $10,500, thus realizing a gain of $2,900.
Your reportable gain is $500: the $2,900 gain minus the $2,400 loss not
allowed to your brother.

Example 2. If in Example 1, you sold the stock for $6,900 instead of $10,500,
your recognized loss is only $700 ($7,600 basis minus $6,900). You cannot
deduct the loss that was not allowed to your brother.

Gain on sale or trade of depreciable property. If you have a recognized
gain on the sale or trade of property, including a leasehold or a patent
application, that is depreciable property in the hands of the party who
receives it, the capital gain provisions do not apply, and the gain is
ordinary income if the transaction is between you and a controlled entity, or
you and a trust in which you or your spouse is a beneficiary. See Chapter 2
in Publication 544 for more information.

Capital Assets and Noncapital Assets

For the most part, everything you own and use for personal purposes, pleasure,
or investment is a capital asset. Some examples are:

∙  Stocks or bonds held in your personal account

∙  A house owned and used by you and your family

∙  Household furnishings

∙  A car used for pleasure or commuting

∙  Coin or stamp collections

∙  Gems and jewelry

∙  Gold, silver, or any other metal

The following items are noncapital assets:

1)  Property held mainly for sale to customers or property that will
    physically become a part of the merchandise that is for sale to
    customers;

2)  Depreciable property used in your trade or business, even though fully
    depreciated;

3)  Real property used in your trade or business;

4)  A copyright, a literary, musical, or artistic composition, a letter
    or memorandum, or similar property:

    a)  That you created by your personal efforts,

    b)  That was prepared or produced for you as a letter, memorandum, or
        similar property, or

    c)  That you acquired under circumstances (for example, by gift)
        entitling you to the basis of a person who created the property
        or for whom it was prepared or produced;

5)  Accounts or notes receivable acquired in the ordinary course of a trade
    or business, or for services rendered as an employee, or from the sale of
    any of the properties described in (1); and

6)  U.S. Government publications that you received from the government free
    or for less than the normal sales price, or that you acquired under
    circumstances entitling you to the basis of someone who received the
    publications free or for less than the normal sales price.

Capital or Ordinary Gain or Loss

If you have a taxable gain or a deductible loss from a transaction, it may be
either a capital gain or loss or an ordinary gain or loss, depending on the
circumstances. In some situations, part of your gain or loss may be a
capital gain or loss and part may be an ordinary gain or loss.

This section discusses the tax treatment of different types of investment
transactions.

For information about transactions that are not discussed here, refer to those
IRS publications described at the beginning of this chapter.

Character of gain or loss. It is important for you to properly distinguish
or classify your gains and losses as either ordinary or capital gains or
losses and as either short-term or long-term gains or losses. The correct
classification helps you figure the limit on capital losses and your proper
tax if you can use the Schedule D Tax Computation.

For information about determining whether your gain or loss was a short-term
or long-term capital gain or loss, see the discussion under Holding Period,
later in this chapter.

Property Held for Personal Use

Property held for personal use is a capital asset. Gain from a sale or
exchange of such property is a capital gain. Losses from sales and exchanges
of such property are not deductible, unless they result from personal
casualties or thefts as discussed in Chapter 26.

Investment Property

Investment property is a capital asset and a gain or loss from its sale or
exchange is generally a capital gain or loss.

Gold, silver, stamps, coins, gems, etc., are capital assets except when they
are held for sale by a dealer. Any gain or loss you have from their sale or
trade generally is a capital gain or loss.

Stocks, stock rights, and bonds (including stock received as a dividend) are
capital assets except when held for sale by a securities dealer. However, if
you own small business stock, see Losses on Small Business Stock in
Publication 550.

Worthless securities. Stocks, stock rights, and corporate or government bonds
with interest coupons or in registered form, which became worthless during
the tax year, are treated as though they were capital assets sold on the last
day of the tax year if they were capital assets in your hands. To determine
whether they are long-term or short-term capital assets, you are considered
to have held the stocks or securities until the last day of the year in which
they became worthless. See Holding Period, later.

If you are a cash-basis taxpayer and make payments on a negotiable promissory
note that you issued for stock that became worthless, you can deduct these
payments as losses in the years you actually make the payments. Do not deduct
them in the year the stock became worthless.

Discounted debt instruments. Treat your gain or loss on the sale, redemption,
or retirement of a bond or other evidence of indebtedness originally issued
at a discount as follows.

Treat gains on short-term federal, state, or local government obligations
as ordinary income up to the ratable share of the acquisition discount. This
treatment applies to obligations that have a fixed maturity date not more than
one year from the date of issue. However, this treatment does not apply for
state or local government obligations with tax-exempt interest. Any gain in
excess of the ratable share of the acquisition discount is capital gain.
Any loss is capital loss. Acquisition discount is the excess of the stated
redemption price at maturity over your basis in the obligation.

However, do not treat such gains as income to the extent you previously
included the discount in income. This amount increases your basis in the
obligation. See Discount on Short-Term Obligations in Publication 550 for
more information.

Treat gains on short-term nongovernment obligations (whether or not
tax exempt) as ordinary income up to the ratable share of original issue
discount (OID). This treatment applies to obligations that are not short-term
government obligations and that have a fixed maturity date of not more than
one year from the date of issue.

However, to the extent you previously included the discount in income, you do
not have to include it in income again. This amount increases your basis. See
Discount on Short-Term Obligations in Publication 550, for more information.

Long-term debt instruments issued after 1954, and before May 28, 1969 (or
before July 2, 1982, if a government issue). If you sell, exchange, or redeem
for a gain one of these debt instruments, the part of your gain due to the
original issue discount (OID) is interest income at the time of the sale or
redemption. The balance of the gain is capital gain. If, however, there was
an intention to call the debt instrument before maturity, the entire amount
of OID is treated as ordinary income at the time of sale. This treatment of
taxable gain also applies to corporate instruments issued after May 27, 1969,
under a written commitment that was binding on that date and thereafter.

See Original Issue Discount (OID) in Chapter 8 for information on OID.

Long-term corporate debt instruments issued after May 27, 1969, and government
instruments issued after July 1, 1982. If you hold one of these debt
instruments, you must include a part of the OID in your gross income each year
that you own the instrument. Your basis in the instrument is increased by the
amount of OID that you have included in your gross income. See Original Issue
Discount (OID) in Chapter 8 for information about the OID that you must
report on your tax return.

If you sell or exchange a debt instrument before it reaches maturity, your
gain on the sale is a capital gain, provided the debt instrument was a capital
asset. Any amount that you receive on the retirement of a debt instrument
is treated in the same way as if you had sold or exchanged that instrument.

However, if at the time the instrument was originally issued there was an
intention to call it before its maturity, your gain on the sale of the
instrument is ordinary income to the extent of the entire OID reduced by any
amounts of OID previously includible in your income. The rest of the gain
is capital gain.

See Capital or Ordinary Gain or Loss in Publication 550 for more information
about the tax treatment on the sale or redemption of discounted debt
instruments.

Tax-exempt state and local government bonds. If these bonds were originally
issued at a discount before September 4, 1982, and you acquired them before
March 2, 1984, treat your part of the OID as tax-exempt interest. Do not
include it in income. However, any gain from market discount is taxable as a
capital gain on disposition or redemption of tax-exempt bonds. You figure the
market discount by subtracting the price you paid for the bond from the sum
of the original issue price of the bond and the amount of accumulated OID
from the date of issue that represented interest to any earlier holders.

You must accrue OID on tax-exempt state and local government bonds issued
after September 3, 1982, and acquired after March 1, 1984. Your adjusted basis
at the time of disposition is figured by adding accrued OID to your basis. You
must accrue OID on tax-exempt obligations under the same method used for OID
on corporate obligations issued after July 1, 1982.

Notes of individuals. If the evidence of indebtedness you bought at a discount
was issued by an individual, its retirement generally will not be given
capital gain treatment. But if you sell the discounted instrument to someone
other than the original borrower, any gain is a capital gain as long as it
was not acquired in the ordinary course of your trade or business for services
rendered or from the sale of inventory. In figuring your adjusted basis in the
note, do not reduce your original basis by any interest payments or by the
part of the principal payments you received that is taxable discount income.

Example. You bought a $10,000 note of an individual for $6,000 on which no
payments had been made. You receive principal payments totaling $4,000. Then
you sell the note for $3,800. Only 60% ($6,000/$10,000) of the $4,000 is a
return of your investment. The balance is discount income. You reduce your
cost by $2,400 ($4,000 * 60%) to figure your adjusted basis. Your capital
gain is $200, figured as follows:

      Selling price of note .........................    $3,800
      Minus adjusted basis of note:
          Cost of note ......................  $6,000
          Minus return on investment ........   2,400     3,600
                                            _________  ________
      Capital gain                                         $200
                                                     ==========

The OID rules discussed in Chapter 8, under Original Issue Discount (OID),
apply to obligations issued by individuals after March 1, 1984. The OID rules
will not apply to loans between individuals in amounts of $10,000 or less
(including the outstanding amounts of prior loans) if the lender is not in
the business of lending money, except if a principal purpose of the loan is
to avoid federal tax.

Obligations issued in bearer form. Generally, any loss on a registration
-required obligation held in bearer form is not deductible. Any gain on the
sale or other disposition of such obligation is ordinary income, unless the
issuer was subject to a tax on the issuance of the obligation.

A registration-required obligation is any obligation except an obligation:

1)  That is issued by a natural person.

2)  That is not of a type offered to the public.

3)  That has a maturity at the date of issue of not more than 1 year.

4)  That was issued before 1983.

Loss on deposits in an insolvent or bankrupt financial institution. If you
can reasonably estimate your loss on a deposit because of the bankruptcy or
insolvency of a qualified financial institution, you can choose to treat the
amount as either a casualty loss or an ordinary loss in the current year.
Either way, you claim the loss as an itemized deduction. Otherwise, you can
wait until the year of final determination of the actual loss and treat the
amount as a nonbusiness bad debt (discussed later under Nonbusiness Bad Debts)
in that year.

If you claim a casualty loss, attach Form 4684, Casualties and Thefts, to your
return. Each loss must be reduced by $100. Your total casualty losses for the
year are reduced by 10% of your adjusted gross income.

If you claim an ordinary loss, report it as a miscellaneous itemized deduction
on line 20 of Schedule A (Form 1040). The maximum amount you can claim is
$20,000 ($10,000 if you are married filing separately) reduced by any expected
state insurance proceeds. Your loss is subject to the 2% of adjusted gross
income limit. You cannot choose to claim an ordinary loss if any part of
the deposit is federally insured.

You cannot choose either of these methods if:

    You own at least 1% of the financial institution,

    You are an officer of the institution, or

    You are related to such an owner or officer.

If the actual loss that is finally determined is more than the amount deducted
as an estimated loss, you can claim the excess loss as a bad debt. If the
actual loss is less than the amount deducted as an estimated loss, you must
include in income (in the final determination year) the excess loss claimed.

Sale of annuity. The part of any gain on the sale of an annuity contract
before its maturity date that is attributable to interest accumulated on
the contract is ordinary income.

Nonbusiness Bad Debts

If someone owes you money that you cannot collect, you have a bad debt. You
may be able to deduct the amount owed to you when you figure your tax for the
year the debt becomes worthless. For a bad debt to qualify for the deduction,
there must be a true creditor-debtor relationship between you and the person
or organization that owes you the money. A debt is genuine if it arises from
a debtor-creditor relationship based on a valid and enforceable obligation to
repay a fixed or determinable sum of money. You must realize a loss because
of your inability to collect the money owed to you.

Bad debts that you did not get in the course of operating your trade or
business are nonbusiness bad debts. To be deductible, nonbusiness bad
debts must be totally worthless. You cannot deduct a partially worthless
nonbusiness bad debt.

To deduct a bad debt, you must have basis in it - that is, you already
included the amount in your income or you loaned out your cash. For example,
you cannot claim a bad debt deduction on a court-ordered but unpaid divorce
settlement. If you are a cash-basis taxpayer, and most individuals are, you
cannot take a bad debt deduction for expected income. Examples include unpaid
salaries, wages, rents, fees, interest, dividends, etc., unless you previously
included the amount in income.

Nonbusiness bad debts are deducted only as short-term capital losses on
Schedule D (Form 1040), Capital Gains and Losses. There are limits on how
capital losses may be deducted. For a discussion of these limits, see
Chapter 17.

For more information, see Nonbusiness Bad Debts in Publication 550.

For information on business bad debts, see Chapter 12 of Publication 535.

How to report bad debts. Nonbusiness bad debts are deducted as short-term
capital losses on Schedule D (Form 1040).

In Part I, line 1d of Schedule D, enter the name of the debtor and "schedule
attached," in column (a), and the amount of the bad debt in column (f). Use
a separate line for each bad debt.

For each bad debt, attach a statement to your return that contains:

1)  A description of the debt, including the amount, and the date it became
    due,

2)  The name of the debtor, and any business or family relationship between
    you and the debtor,

3)  The efforts you made to collect the debt, and

4)  Why you decided the debt was worthless. For example, you could show
    that the borrower has declared bankruptcy, or that legal action to
    collect would probably not result in payment of any part of the debt.

Losses on Small Business Stock

You are allowed to deduct as an ordinary loss, rather than as a capital loss,
your loss on the sale, exchange, or worthlessness of certain stock you own in
a small business corporation or certain stock in a small business investment
company. Gain on this stock is capital gain and is reported on Schedule D
(Form 1040) if the stock is a capital asset in your hands. See Losses on
Small Business Stock and Losses on Small Business Investment Company Stock
in Publication 550.

Holding Period

If you sold or traded investment property, you must determine whether the
gain or loss is a short-term or long-term capital gain or loss by determining
your holding period.

Long term or short term. If you hold investment property more than one year,
your gain or loss is a long-term capital gain or loss. If you hold the
property one year or less, your gain or loss is a short-term capital gain
or loss.

To figure how long you held the investment property, begin counting on the
date after the day you acquired the property. The same date of each following
month is the beginning of a new month regardless of the number of days in the
preceding month. The day you disposed of the property is part of your holding
period.

Example. If you buy investment property on February 1, 1992, you start
counting on February 2. The 2nd of each following month is the beginning of a
new month. If you sell the property on February 1, 1993, your holding period
is not more than one year and you will have a short-term capital gain or loss.
If you sell it on February 2, 1993, your holding period is more than one year
and you will have a long-term capital gain or loss.

Securities traded on established market. For securities traded on an
established securities market, your holding period begins the day after
the trading date you bought the securities, and ends on the trading date
you sold them. Ignore the settlement date for holding period purposes.

Example. You are a cash-basis, calendar-year taxpayer. You sold stock at a
gain on December 27, 1992. According to the rules of the stock exchange, the
sale was closed by delivery of the stock 5 trading days after the sale, on
January 6, 1993. You received payment of the sales price on that same day.
Report your gain on your 1992 return, even though you received the payment
in 1993. The gain is long term or short term depending on whether you held
the stock more than one year. Your holding period ended on December 27 (the
trading date). If you had sold the stock at a loss, you would also report
it on your 1992 return.

Nontaxable trades. If you acquire investment property in a trade for other
investment property and your basis for the new property is determined, in
whole or in part, by your basis in the old property, your holding period of
the new property begins on the day following the date you acquired the old
property. Chapter 14 discusses basis.

Property received as a gift. If you receive a gift of property and your basis
is determined by the donor's basis, your holding period is considered to have
started on the same day as the donor's holding period. See Property Received
as a Gift in Chapter 14.

If your basis is determined by the fair market value of the property,
your holding period starts on the day after the date of the gift.

Inherited property. If you inherit investment property and your basis for
it is:

1)  Determined with reference to its fair market value at the date of the
    decedent's death,

2)  Determined with reference to its fair market value at the alternate
    valuation date, or

3)  The decedent's adjusted basis (for appreciated property),

your gain or loss on any later disposition of such property is treated as a
long-term capital gain or loss. You are considered to have held the property
for more than one year, even if you dispose of it within one year after the
decedent's death. See Inherited Property in Publication 551, Basis of Assets.

Real property bought. To figure how long you have held real property bought
under an unconditional contract, begin counting on the earlier of the day
after you received title to it, or the day after you took possession and
assumed the burdens and privileges of ownership. However, taking delivery or
possession of real property under an option agreement is not enough to start
the holding period. The holding period cannot start until there is an actual
contract of sale. The holding period of the seller cannot end before that
time.

Mutual fund stock. If you received exempt-interest dividends on mutual fund
stock that you held 6 months or less and sold at a loss, you cannot claim the
part of the loss that is equal to or less than the exempt-interest dividends.
You must report the rest of the loss as a short-term capital loss.

See Publication 564, Mutual Fund Distributions, for more information on
mutual fund distributions.

Real estate investment trust (REIT). If you received a capital gain
distribution on REIT stock that you held 6 months or less and sold at a loss,
you report as a long-term capital loss the part of the loss that is equal
to, or less than, the long-term capital gain distribution. This rule does
not apply to dispositions of stock under a periodic liquidation plan. See
Capital Gain Distributions in Chapter 9 for information on capital gain
distributions.

Automatic investment service and dividend reinvestment plans. If you take part
in a plan to buy stock through a bank or other agent, the date the bank or
other agent buys the stock is your purchase date for figuring the holding
period of that stock. In determining your holding period for shares bought
by the bank or agent, full shares are considered bought first and any partial
shares are considered bought last. If a full share or a partial share was
bought over a period of more than one purchase date, your holding period for
that share is a split holding period. A part of the share is considered to
have been bought on each date that stock was bought by the bank or other agent
with the proceeds of available funds.

Nontaxable stock dividend. The holding period for new stock you received as a
nontaxable stock dividend begins on the same day as the holding period of the
old stock. This rule also applies to stock acquired in a "spin-off," which is
a distribution of stock or securities in a controlled corporation.

Nontaxable stock rights. Your holding period for nontaxable stock rights
begins on the same day as the holding period of the underlying stock. The
holding period for stock acquired through the exercise of stock rights
begins on the date the right was exercised.