IRS Form 4797 reports profits or losses incurred by your trade or business. All gains and losses are classified as either “ordinary” or “capital” for tax purposes. Gains and losses realized in the course of doing business and the sale of non-capital assets are typically ordinary, whereas those that are the result of selling or exchanging a capital asset are generally capital gains and losses. It can be an admittedly confusing difference.
Ordinary vs. Capital Gains and Losses
Ordinary losses can be used to offset other income, but capital losses can only be used to offset capital gains.
Ordinary gains are taxed as ordinary income. Capital gains are either long-term or short-term, depending on how long they’re held — those held for a year or less are considered short-term. Long- and short-term capital gains are taxed at different rates. Here’s what you need to know if you’re dealing with ordinary gains.
Losses on the sale of business assets are ordinary losses and are not subject to the $3,000 limit on losses like capital losses.
What Are Noncapital Assets?
According to the Internal Revenue Service, the following fall into the category of noncapital assets:
- Inventory and other property intended for sale to customers
- Supplies necessary to conduct your business
- Accounts receivable acquired in the ordinary cost of doing business
- Depreciable property
- Real property used as rental property
- Copyrights, intellectual property, and musical, literary or artistic compositions
- Some commodities derivative financial instruments held by a commoditiesderivatives dealer
- Some hedging transactions
As a general rule, anything you own for personal use or investment, such as stocks and bonds, is a capital asset.
The sale of an otherwise capital asset can be treated as an ordinary gain or loss if the exchange is made to a related person, such as between the executor and beneficiary of an estate, or between you personally and your business entity.
From 4797 and Schedule D
Report any profit or loss from the sale of assets used in your trade or business using Form 4797:
If the same asset was used for both business and personal purposes, you must allocate any gain realized between Form 4797 and Schedule D, “Capital Gains and Losses.”
For example, you may use your house — which is depreciable — partly as a residence and partly as your office. Gains on the sale of business assets that are not capital assets are ordinary gains and taxed at ordinary income tax rates. These gains do not qualify for capital gains treatment.
Ordinary Gains: Form 1040 Line 14
Enter your resulting gain or loss on line 14 (“Other gains and losses”) of Form 1040 after you’ve completed the calculations on Form 4797. Attach Form 4797.
NOTE: Tax laws can change frequently and the above information may not reflect recent changes. Please consult with a tax professional for the most up-to-date advice before filing your tax return if you’re dealing with ordinary vs. capital gains and are uncertain where you stand. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.