In this example, we have Karla,

who has a short-term capital loss of $12,000,

a short-term capital gain of $5,000,

a long-term capital gain from a stock sale of $6,000,

and a section 1231 gain of $1,200.

How are the above gains and losses netted together?

At what tax rates are the items taxable or deductible?

First, let's review our three steps to

setup the gains and losses for the netting procedure.

First, we simply categorize the gains and losses in the appropriate type,

whether short-term, or long-term, or Section 1231.

Second, we net any individual gains and losses

within each category to get one net number.

Third, we net across categories moving from left to right using our netting map.

So, let's work with our example using the netting map as the background.

Note, now, we've added a Section 1231,

column on the leftmost side.

But we still have our familiar short-term capital gain or loss category,

or three long-term capital gain categories,

and our ordinary income or loss category.

First, let's just start with a new item in this example,

the Section 1231 item.

Here, Karla has a Section 1231 gain of $1,200.

Our first step is to simply put it in the appropriate column.

As I'm sure you guessed,

we put this $1200 Section 1231 gain in the Section 1231 column.

Next, Karla has a short-term capital loss of $12,000.

What do we do with this $12,000?

Well, we place it in the short-term capital column.

Next, she has a short-term capital gain of $5,000,

which column does this go into?

Well, you guessed that we place the $5,000 gain also in the short-term capital column.

Next, Karla has a long-term capital gain from

the stock sale of $6,000, where does that go?

Well, since this is a stock sale,

we'll take that $6,000 and place it in the 0,15, 20 percent column.

Okay. So, we've placed the gain and loss items in the right categories,

the second step of the ordering procedure is to net within each column,

so that we're left with only one number in each column.

Let's first note the section 1231 column.

Well, there's only one number here,

so we keep $1,200.

Now, if there was also a separate loss in the section 1231 column,

we would just net the gain with the loss,

but here we just have a net section 1231 gain.

Next, the short-term capital column,

we have a $12,000 loss and a $5,000 gain.

So, we connect them together.

We're left with a $7,000 net short-term capital loss.

We now move to the last Long-Term Capital column.

Again, there's only one number here,

so we keep the $6,000 gain in the 0,15, 20 percent column.

So, not much else left to net within each column.

So, we're done with step two,

the ordering procedure, we have one net number in each column.

Our third step now is to net across columns,

moving from left to right using our netting map directions.

So, we start with the section 1231 column.

The netting map says that if we have a net section 1231 gain,

this number moves to the 0,15,

20 percent long-term capital gain column.

Note that there's no look-back loss issue here.

So, we don't have to worry about reclassifying any of

this net 1231 gain as ordinary income.

So, we take this $1,200 and move

the entire amount directly into the 0,15, 20 percent column.

We will add it to the $6,000 and now we have $7,200 total in the 0,15, 20 percent column.

Now, because we move the section 1231 amount out of the section 1231 column,

nothing is left there.

So, we move to the right one column.

So, next, we'll look at the short-term capital gain or loss column.

Notice here, we have a $7,000 net short-term capital loss.

Also note that the long-term capital items have a gain,

that is, they are of opposite sign as a short-term loss item.

Therefore, we can net the short-term items with the long-term items.

So, we have the $7,000 net short-term capital loss,

and we move it to the 0,15, 20 percent column.

We net it with a $7,200 net long-term capital gain,

and we're left with $200 net long-term capital gains.

Given that this is a gain,

and were in the 0,15,

20 column, we do not take it over one more column to be taxed at ordinary rates.

That is, because we're left with a long-term capital gain,

it should get preferential tax rate treatment.

Therefore, this $200 will be taxed at the applicable long-term capital gains rate.

Okay. Now, a small twist.

What happens if we assume all the same facts,

except that Karla has qualified dividends of $250 that she earned from the stock.

Can the $250 qualified dividend offset any of the losses or be added to the gains?

Here, the answer is technically no,

the dividend income cannot offset any of the short-term capital loss,

and technically we do not add it to the long-term capital gains either.

Now, it just so happens that the $250 dividend

will also be taxed at the same preferential rate of 15 percent,

but technically, it doesn't appear anywhere on the netting map.

Okay. Let's ignore the dividends,

but add one new fact to our example.

Let's also say that Karla has $150 of Section 1231

lookback losses that were deducted in the last five years as an ordinary loss,

how do we deal with these prior year losses?

Well, we have to turn back to our netting map,

and do our ordering procedure, that is,

we have to first put everything in the right column,

then net within each column,

and then net across the columns moving from left to right.

So, let's start off with putting everything in the right column.

These are all the same facts,

so I already have the correct classifications.

In the next step, we net within each column,

also same numbers as before.

So, what about this lookback loss?

Well, we only consider the lookback loss in the case where we have

a net section 1231 gain in the current year.

So, we have to do everything up to netting within

each column before considering the look-back loss.

This is important because it could be the case that in the current year,

we might have a net section 1231 loss.

If this were the case, then the lookback loss is actually irrelevant.

If we have a current year Section 1231 loss,

we would just then move that loss to the ordinary column when we net across columns,

and simply deduct it.

But here, we have a net section 1231 gain in the current year.

So, what this means is that when we want to net across columns next,

we have to reclassify some of this gain as ordinary income.

Specifically, only the section 1231 gain that survives

the lookback loss reclassification will be moved to the 0,15, 20 percent column.

So, here we input the $150 section 1231 lookback loss in the 1231 column.

Again, this is a reclassification,

it's not an actual loss.

It reclassifies a part of the net section 1231 gain as an ordinary gain.

So that less is available to be moved to the 0,15, 20 column.

In other words, we're just moving the $150 to the ordinary income column.

So now, Karla only has $1,050 left in

the net section 1231 column that survived the lookback loss.

It is only this remaining amount that's eligible for the 0,15,

20 percent long-term capital gain treatment.

So, in our third step,

as we net across columns,

we take this $1,050 and move it to the 0,15, 20 percent column.

We add it to the $6,000 gain from the stock sale to give a $7,050 in the 0,15,

20 percent net long-term capital gain column.

Now, we have nothing left in our 1231 column,

$150 was moved to the ordinary column,

while the $1,050 was moved to the 0,15, 20 percent column.

As we move left to right,

next we'll deal with the short-term capital column.

Again, here we have a $7,000 short-term capital loss.

Because this column reports a loss,

and the long-term column reports and gain,

we can net the two columns together.

So, as we move the $7,000 net short-term capital loss to the 0,15,

20 percent long-term capital gain column,

and net it with a $7,050 gain,

we're left with $50 of net 0,15,

20 percent long-term capital gains.

A final point here.

Notice that in total,

Karla is still reporting $200 in gains,

exactly as what we had in our previous example,

where there were no lookback losses.

All the lookback loss did was shift or reclassify

$150 of the section 1231 gains out of what would have been eligible for the 0,15,

20 percent column, and moved it into the ordinary income column.

So importantly, the lookback loss does not represent a real loss.

So, we do not net it against the gains per say.

The presence of these losses signals that we should only

reclassify the current year net 1231 gain as ordinary income.

In summary, this video introduced

Section 1231 Assets and how they're netted with the other categories of gains and losses.

Section 1231 Assets include any real property,

or depreciable personal property that's used in a trade or business,

or for the production of income.

Importantly, these assets must be held long-term to be classified as Section 1231 Assets.

The tax treatment for these assets is very advantageous.

On the gain side,

Section 1231 Assets receive preferential long-term capital gains treatment,

taxes 0,15 or 20 percent,.

On the loss side,

Section 1231 Assets allow the deduction of losses in full against ordinary income.

There is a small wrinkle in this advantageous tax treatment,

and that if the company claimed any section 1231 losses in any of the last five years,

then the current year net 1231 gains up to

these lookback losses will be reclassified as ordinary income,

and will not otherwise be eligible for

preferential tax retreatment at 0,15 or 20 percent.

However, if the net 1231 gain is larger than any remaining 1231 look back losses,

or if the look-back losses do not exist,

then the net section 1231 gains are indeed subject to the 0,15,

20 percent preferential tax rates.