The capital loss limitation isn't the hard part; any first-year associate can memorize "$3,000." The real REG trap is correctly netting gains and losses across different rate buckets before applying that limit, a sequencing error that silently torpedoes scores on exam day.
For the CPA REG exam, you must master the capital asset definition (IRC §1221), the precise netting process for short-term and long-term rate buckets (0/15/20%, 25%, 28%), the $3,000 annual loss deduction limit, and special rules like wash sales (IRC §1091) and Section 1231 assets.
Key facts
- Official Body: American Institute of Certified Public Accountants (AICPA)
- Exam Section: Regulation (REG)
- Passing Score: 75 on a 0-99 scale
- Net Capital Loss Limit (Individuals): $3,000 per year against ordinary income
- Capital Loss Carryover (Individuals): Indefinite, retains character (short-term vs. long-term)
- Capital Loss Carryover (C-Corps): Back 3 years, forward 5 years; always treated as short-term
Why Does Capital Gain & Loss Netting Matter on the REG Exam?
Capital gains and losses are the profit or loss from selling a capital asset. On the CPA REG exam, this is a core competency tested through complex problems designed to expose weak judgment, not just poor memory.
A capital asset, defined by exclusion in IRC §1221, is property held by a taxpayer. The code is clearer on what it is not: inventory, accounts receivable, and depreciable property used in a business. This last category—depreciable business property—falls under Section 1231, a separate set of rules you must apply before you even get to capital gain netting. This is a common first hurdle where candidates stumble.
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On the exam, you won't get a simple definition question. You will get a task-based simulation (TBS) with a dozen transactions, forcing you to classify each, handle any Section 1231 assets, identify wash sales, and then perform the full capital gain and loss netting process.
The single biggest mistake is oversimplifying this netting. Candidates incorrectly lump all gains and losses together. This is a fatal error. The exam demands you navigate a specific hierarchy of netting short-term items, then long-term items in their separate tax rate buckets. Getting the sequence wrong leads you directly to a well-crafted distractor answer.
What Are the Core Capital Gain Rules Tested on the Exam?
Mastering this topic means internalizing the mechanics. You need to build a mental flowchart that you can execute under pressure.
The Capital Asset Definition (and its major exception)
Your starting point is always classification. Is it a capital asset? Remember, stocks, bonds, and personal-use property are capital assets. Inventory and accounts receivable are not.
The big exception is Section 1231 assets: depreciable property and land used in a trade or business held for over one year. Gains and losses on these assets are netted separately. A net §1231 gain is treated as a long-term capital gain, while a net §1231 loss is an ordinary loss. This is a major topic in itself, but for capital gain purposes, know that a net §1231 gain feeds into your long-term capital gain bucket.
The Capital Gains Tax Rate Buckets
You can't understand the netting process without knowing why it exists. It's all about separating gains that are taxed at different rates. For individuals, there are three main long-term buckets:
- 0/15/20%: The standard rate for most long-term capital gains on assets like stocks and bonds. The rate depends on the taxpayer's taxable income.
- 25%: For unrecaptured Section 1250 gain, which relates to the depreciation taken on real property.
- 28%: For collectibles (art, antiques, stamps) and the taxable portion of gain on qualified small business stock (Section 1202).
Short-term capital gains are taxed at ordinary income rates. The whole point of the complex netting process is to ensure losses are applied against gains in the proper, tax-code-mandated order.
The Netting Process: The Real Test
This is where scores are made or lost. The process is rigid. Follow these steps exactly.
| Step | Action | The Critical Detail |
|---|---|---|
| 1 | Net all short-term capital gains and losses. | This results in a Net Short-Term Capital Gain (NSTCG) or Loss (NSTCL). |
| 2 | Net long-term gains and losses within each rate group (28%, 25%, 0/15/20%). | This gives you a net gain or loss for each separate long-term bucket. |
| 3 | Net the results of the long-term groups against each other. | This is the most-failed step. If you have a mix of gains and losses across the buckets, a net loss from one bucket offsets gains in a specific order. A net loss in the 28% group first offsets gain in the 25% group, then the 0/15/20% group. A net loss in the 0/15/20% group first offsets gain in the 28% group, then the 25% group. |
| 4 | Net the overall long-term result with the short-term result. | If one is a gain and the other is a loss, you net them. This gives you your final Net Capital Gain or Loss. |
Examiners write questions where applying losses in the wrong order in Step 3 creates an answer that looks plausible but is fundamentally incorrect. You can test your netting skills with VoraPrep's REG practice questions to build the necessary muscle memory.
Net Capital Loss Limitations (IRC §1211)
For individuals, the maximum net capital loss you can deduct against ordinary income (like salary) is $3,000 per year.
Myth: Any $3,000 of loss can be used. Reality: The character matters. If you have both a net short-term capital loss and a net long-term capital loss, you must use the short-term loss first to make up the $3,000 deduction. This is a critical detail.For C-Corporations, the rule is completely different. A C-Corp can only use capital losses to offset capital gains. They get no deduction against ordinary income.
Capital Loss Carryover (IRC §1212)
For an individual, any unused capital loss is carried forward indefinitely. It also retains its character. A $7,000 short-term loss carryover will offset short-term gains first in the next year.
For a C-Corporation, any net capital loss is carried back three years and forward five years. Crucially, it is always treated as a short-term capital loss on carryover, regardless of its original character.
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Wash Sales (IRC §1091)
If you sell a security at a loss and buy "substantially identical" stock within 30 days before or after the sale, the loss is disallowed for that year. The disallowed loss is not lost forever; it is added to the basis of the new stock, effectively deferring the loss recognition. The holding period of the original stock also tacks on to the new stock.
Worthless Securities (IRC §165(g))
This is a classic timing trap. If a security becomes completely worthless, the loss is treated as occurring on the last day of the tax year.
The Trap: This rule does not automatically make the loss long-term. It simply sets the sale date. You still measure the holding period from the acquisition date to December 31 of the year of worthlessness.- Correct Example: You buy stock on February 10, 2026. It becomes worthless on August 15, 2026. The "sale" date is deemed to be December 31, 2026. Your holding period is from Feb. 10 to Dec. 31, which is less than one year. This is a short-term capital loss.
- How it becomes long-term: If you had bought the stock on February 10, 2025, and it became worthless in 2026, the deemed sale date of Dec. 31, 2026, would make the holding period more than one year, resulting in a long-term capital loss.
Worked Example: Putting It All Together
Let's walk through a realistic scenario that combines these concepts.
Scenario: For tax year 2026, Maya, a single individual, has a salary of $120,000. She engages in the following stock transactions:- Sells 100 shares of TechCorp for a $5,000 short-term capital gain (STCG).
- Sells 50 shares of OldCo for an $11,000 long-term capital loss (LTCL) from the 0/15/20% group.
- On November 10, she sells 200 shares of Utility Inc. for a $4,000 loss.
- On November 25, she buys 200 shares of Utility Inc. again.
Here’s how to think through it, step-by-step.
Step 1: Identify and address any special rules first. Before netting, scan for issues. The Utility Inc. transaction is a wash sale under IRC §1091. She sold at a loss and repurchased within 30 days. The $4,000 loss is disallowed in 2026 and added to the basis of her new shares. For this year's calculation, that loss is ignored. Step 2: Segregate and net the remaining gains and losses.- Short-term: +$5,000 STCG (This is our Net Short-Term Capital Gain)
- Long-term: -$11,000 LTCL (This is our Net Long-Term Capital Loss)
This multi-step judgment is exactly what the REG exam tests. The VoraPrep adaptive learning engine identifies if you're weak in a specific step and serves you more questions to strengthen that skill.
Practice Questions: Test Yourself on Capital Gains and Losses
Theory is one thing; application is another. VoraPrep has over 9,500 questions, including many on these specific REG topics.
Sample Question 1: On May 15, 2026, Chloe, a single taxpayer, sold 200 shares of publicly traded Zenith Inc. stock for a realized loss of $8,000. Chloe had originally purchased the stock on January 10, 2026. On June 1, 2026, Chloe purchased 150 shares of Zenith Inc. stock. What is the amount of loss that Chloe can recognize on her 2026 tax return from these transactions?How Should You Prepare for This Topic?
Myth: You need to be a tax genius to pass REG. Reality: You need to be a disciplined practitioner who follows a process.Your weekly drill should be to practice the full netting process. Take a piece of paper and create four columns: Short-Term, LT 28%, LT 25%, and LT 0/15/20%. Work through five complex practice problems, physically writing the numbers in the columns and netting them in the correct order as outlined in the table above. This builds the muscle memory that holds up under exam pressure.
In the final week before your exam, focus on process. Redo your netting drills. Review the C-Corp vs. individual capital loss rules side-by-side. Confirm you know the wash sale basis adjustment cold. Confidence comes from knowing your process is sound.