For the 'who must file' determination, should net capital gain or gross sales amount be used?
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For the purpose of determining whether you must file a federal income tax return—such as for the Form 8898 filing threshold or the general filing requirement under IRC §6012—the correct measure is your gross income, not your gross sales (proceeds) amount. When it comes to sales or exchanges of property (such as stocks, bonds, or real estate), gross income is defined as the net gain from the sale, not the total amount of sales proceeds.
Legal Analysis
1. Definition of Gross Income for Filing Purposes
- IRC §61(a)(3) includes in gross income "gains derived from dealings in property."
- Treas. Reg. §1.61-6(a) clarifies that gross income from the sale or exchange of property is the gain realized, which is the excess of the amount realized over the unrecovered cost or other basis for the property sold or exchanged.
- IRC §1001(a): Gain from the sale or other disposition of property is the excess of the amount realized over the adjusted basis.
2. Filing Requirement
- IRC §6012(a)(1): An individual must file a return if their gross income equals or exceeds the sum of the exemption amount plus the applicable standard deduction.
- For sales of property, gross income is the net gain, not the gross proceeds.
3. IRS Guidance
- SCA 200018051: The IRS specifically addressed this issue and concluded that a taxpayer is not required to file a return if their only income is a gain from the sale of property and that gain is less than the gross income threshold for filing a return, regardless of the amount of proceeds reported on Form 1099-B. The Service Center Advice states:
"A taxpayer is not required to file an income tax return if the gross income for the year is a gain from the sale of property which is less than the gross income threshold for filing an income tax return regardless of the amount of proceeds reported on Form 1099-B."
4. Application to Form 8898
- The Instructions for Form 8898 define "worldwide gross income" as all income received in the form of money, goods, property, and services, including any income from sources outside the United States, and before any deductions, credits, or rebates. However, for sales of property, the amount included in worldwide gross income is the gain (amount realized minus adjusted basis), not the gross sales price.
5. Supporting IRS Publications
- Publication 550 and Publication 544 both confirm that for sales of property, the amount included in gross income is the gain (or loss), not the gross proceeds.
6. Conclusion
For the "who must file" determination, you should use the net capital gain (i.e., the gain realized from the sale or exchange of property, which is the amount realized minus the adjusted basis), not the gross sales amount. Only the net gain is included in gross income for purposes of determining whether you meet the filing threshold. The gross sales amount (proceeds) is not used for this purpose.
If your only income is from the sale of property and your net gain is less than the filing threshold, you are not required to file a return, even if the gross proceeds are much higher. This rule applies to both the general filing requirement and the Form 8898 threshold.
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