A taxpayer has $10,000 of short-term capital losses and $5,000 of long-term capital gains in Year 1. They also have $100,000 of ordinary income. What is the effect on their taxable income?

Answer options:

Deduct $10,000 loss against ordinary income.

Offset $5,000 LTCG; Deduct $3,000 against ordinary income; Carryforward $2,000.

Offset $5,000 LTCG; Deduct $5,000 against ordinary income.

Deduct $3,000; Carryforward $7,000.

How to approach this question

1. Net Capital Gains/Losses: ($10,000) STCL + $5,000 LTCG = ($5,000) Net Short-Term Capital Loss. 2. Deduction Limit: Max $3,000 against ordinary income. 3. Apply Deduction: Use $3,000 of the ($5,000) loss. 4. Carryforward: Remaining ($2,000) STCL carried forward.

Full Answer

B.Offset $5,000 LTCG; Deduct $3,000 against ordinary income; Carryforward $2,000.✓ Correct

First, the $10,000 short-term loss offsets the $5,000 long-term gain, leaving a net short-term loss of $5,000. The taxpayer can deduct up to $3,000 against ordinary income. The remaining $2,000 is carried forward.

Common mistakes

Failing to net the gains and losses first, or ignoring the $3,000 annual limit.

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