The Effects of Federal Revenue Acts of 1938, 1939, and 1940 on the Realization of Gains and Losses on Securities

Abstract

T HE PURPOSF, of this study is to examine certain mathematical aspects to be considered in realizing gains and losses on securities under the Federal Revenue Acts of 1938, 1939, and 1940. The fiscal wisdom of the tax treatment of these gains and losses is not here the subject of discussion; but the formulae subsequently developed may prove useful to persons interested in the economic appraisal of this feature of the tax system. This analysis is directed mainly to the problems of the security holder who is confronted with the question of realizing gains and losses and who may require mathematical aid in reaching a decision. In the process of appraising security holdings, the question of sale of certain securities and reinvestment of funds continuously arises. Such transactions should not be undertaken without full knowledge of the effects of the tax treatment of the gains or losses to be realized. Thorough analysis of these effects may have important bearing on the decision to be made. The sole purpose of this article is to provide for the investor a reasonably simple method for evaluating the tax factor. The Revenue Act of 19381 further modified the specialized treatment of gains and losses from sales of securities and other similar property under prior legislation. This statute defines capital to exclude property held primarily for sale in the ordinary course of trade and property included in the inventory of the taxpayer conducting a business; and it also excludes property that is subject to a statutory depreciation deduction. Stocks and bonds are the most important but not the only type of asset falling within the definition of capital assets. Gains and losses from sale of assets are divided into two broad classes: (a) if the property has been held not more than 18 months; and (b) long if it has been held longer than 18 months. Individual taxpayers are permitted to offset short term gains with short term losses. If a net short term gain is realized, it is included in the gross income of the taxpayer; if a net short term loss is realized, it may not be deducted from gross income but it may be used in an amount not in excess of the net income for such year as an offset to net