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Welcome back, recall from the previous video,

we introduced the idea of character of gains and losses.

The character of recognized gains and losses matters because it'll determine

which tax rate the taxpayer will use to calculate his or her tax liability.

The type of asset, whether ordinary, capital or Section 1231,

will determine the character of the income or loss.

In this video, I'll introduce the netting process.

Here the netting process is the most important aspect in determining the gain

and loss amounts in tax treatment.

Here let's just make sure we introduce some very basic definitions.

Let's say we have two capital assets, and one is sold at a gain and

one's sold at a loss.

How do we tax these two gains and losses?

Well, basically, we can combine, or net,

the gain with the loss to determine whether we have a net gain or a net loss.

If a short-term capital gain on the first asset is greater than

the short-term capital loss on the second asset,

we can net the two, and we'll get a net short-term capital gain.

If the short-term capital gain on the first asset is smaller than the short-term

capital loss on the second asset, and we net the two,

we get a net short-term capital loss.

The same idea goes for long-term capital gains and losses.

If a long-term capital gain is greater than a long-term capital loss, and

we net the two, we get a net long-term capital gain.

And if our long-term capital gain is smaller than our long-term capital loss,

and we net the two, we get a net long-term capital loss.

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Importantly, net short-term capital gains are taxed at ordinary tax rates.

And net short-term capital losses provide for an ordinary tax deduction,

that is, a deduction against ordinary income, but

only up to $3,000 for individuals per year.

This is a for AGI deduction.

This $3,000 deduction limitation also applies if the loss

is a net long-term capital loss.

And note that the limit is $3,000 total for all short-term and

long-term net losses combined.

It's not a $3,000 limit for short-term losses and

another $3,000 limit for long-term losses.

Also note, that it's a $3,000 limit for all individual tax pair filing statuses.

So for example, a married-filing joint taxpayer will not get a $6,000

net capital loss limitation, even though there are two people on the tax return.

The limit stays at $3,000 per year, which is, in fact,

the same as a single person's limitation.

So we now know how three of the four netted items are taxed.

We've covered net short-term capital gains and both net short-term and

long- term capital losses.

So how are net long-term capital gains taxed?

The answer is it depends.

This is slightly more complicated.

Here net long-term capital gains are eligible for preferential tax rates, but

they actually depend on the individual's ordinary income tax bracket.

Here the preferential tax rate is actually 0% if the individual's ordinary

income tax bracket is 10% or 15%, that is, the bottom two tax brackets.

At the opposite end, the top preferential tax rate is 20% if

the individual is in the top ordinary income tax bracket.

And an intermediate preferential tax rate of 15% applies if the ordinary income

tax bracket that applies to the individual is somewhere between the bottom

two brackets and the top bracket.

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There are other net long-term capital gains tax rates as well.

The first is the 25% tax rate on unrecaptured Section 1250 gains.

This is related to gains from the disposition of some Section 1231 assets.

I'll discuss this special case in a later video, but for now,

if we mention unrecaptured Section 1250 gains,

it should ring a bell that this is a 25% long-term capital gain item.

The final long-term capital gain rate is 28%, which is the tax rate applied

to the sale of collectibles, which includes things like artwork, antiques,

rugs, metals, gems, stamps, alcohol, coins or other historical objects.

So what happens here with the netting process is we're trying to figure out

the character of our gains and

losses during the year on all of the assets we've sold that year.

For example, maybe I sold some stock, and a car, and

some business equipment, and an antique bottle of wine.

How is all of this stuff taxed?

Can we combine any of these gains and losses and net them?

If we can, how do we net them?

And at what tax rate are the gains taxable or the losses deductible?

And if the losses are deductible, are they entirely deductible or limited?

This is what the netting process will address.