REG CPA Practice Questions Explained: Calculate Capital Gains from the Sale of Investments and Virtual Currencies

In this video, we walk through 5 REG practice questions demonstrating how to calculate capital gains from the sale of investments and virtual currencies to be included in an individual’s gross income. These questions are from REG content area 4 on the AICPA CPA exam blueprints: Federal Taxation of Individuals.

The best way to use this video is to pause each time we get to a new question in the video, and then make your own attempt at the question before watching us go through it.

Also be sure to watch one of our free webinars on the 6 “key ingredients” to an extremely effective & efficient CPA study process here…

How to Calculate Capital Gains from the Sale of Investments and Virtual Currencies

Calculating capital gains and integrating them into an individual’s gross income involves a series of steps, taking into account the nature of the gains (whether from investments like stocks or bonds, or virtual currencies like Bitcoin), the period over which the assets were held, and the rules for offsetting gains with losses. Here’s a detailed overview of the process:

1. Determine the Type of Asset Sold

First, identify the asset type:

• Investments: These can include stocks, bonds, mutual funds, and other securities.
• Virtual Currencies: This category includes cryptocurrencies like Bitcoin, Ethereum, etc.

2. Calculate the Gain or Loss

For each asset sold, calculate the capital gain or loss using the formula: Capital Gain (or Loss) = Selling Price − Basis

The “basis” is typically the purchase price plus any associated costs (like commissions or fees). If the asset was received as a gift or inheritance, special rules apply to determine the basis.

3. Determine the Holding Period

• Short-term: Assets held for one year or less before selling are subject to short-term capital gains tax.
• Long-term: Assets held for more than one year benefit from lower long-term capital gains tax rates.

The holding period affects the tax rate applied to your capital gains.

4. Netting Capital Gains and Losses

You must net your short-term and long-term gains and losses separately:

• Step 1: Offset short-term gains with short-term losses to determine your net short-term gain or loss.
• Step 2: Do the same for long-term gains and losses.
• Step 3: If you have both short-term and long-term gains, they are taxed separately according to their respective tax rates.
• Step 4: If you have net losses in one category, you can use them to offset net gains in the other category.

5. $3,000 Capital Loss Limit

• If your total net capital loss exceeds your total net capital gain, you can deduct the loss from your ordinary income up to a limit of $3,000 ($1,500 if married filing separately).
• Any loss beyond this can be carried over to future years to offset capital gains or ordinary income, adhering to the same annual limits.

6. Include Net Capital Gains in Gross Income

• Short-term gains are taxed as ordinary income, according to your tax bracket.
• Long-term gains are taxed at lower rates, which are typically 0%, 15%, or 20%, depending on your income level.

Your net capital gain (after offsetting gains with losses as described) is included in your gross income, which then determines your taxable income for the year.

Additional Considerations:

• Special rules apply for virtual currencies, such as the need to track transactions in fiat currency equivalent at the time of each transaction. (Fiat currency is currency that is legal tender but not backed by a physical commodity such as gold or silver; examples would be the US Dollar or the Euro).
• The wash sale rule prevents you from claiming a tax deduction for a security sold in a loss if you repurchase the same or substantially identical security within 30 days before or after the sale.

Example:

John has made several transactions in the tax year:

• Bought 100 shares of Company A at $50 each and sold them at $70 each after 14 months.
• Bought 1 Bitcoin for $10,000 and sold it for $15,000 after 6 months.
• Bought 50 shares of Company B at $100 each and sold them at $80 each after 10 months.
• Had a loss carryover from the previous year of $2,000 in long-term losses.

Step-by-Step Calculation:

1. Determine Gains and Losses for Each Transaction:
   • Company A shares: (100 × $70) – (100 × $50) = $2,000 (long-term gain)
   • Bitcoin: $15,000 – $10,000 = $5,000 (short-term gain)
   • Company B shares: (50 × $80) – (50 × $100) = -$1,000 (short-term loss)
2. Netting Gains and Losses:
   • Short-term: $5,000 (gain from Bitcoin) – $1,000 (loss from Company B) = $4,000 net short-term gain.
   • Long-term: $2,000 (gain from Company A) + (-$2,000) (loss carryover) = $0 net long-term gain.
3. Apply the $3,000 Loss Limit:
   • Since John only has gains and no net capital loss exceeding gains, this step does not apply. However, if John had a net capital loss after offsetting gains, he could deduct up to $3,000 from his other income.
4. Include in Gross Income:
   • John includes $4,000 as short-term capital gains in his gross income, taxed at his ordinary income tax rate.
   • The long-term gains net out to $0, so no long-term gain is included in his gross income.