April 15th snuck up on Dean and bloodied his nose. He looked over his prepared tax forms and shook his head reluctantly writing out the IRS check. He had had an awful 1996 in the stock market, yet his Schedule D, the Capital Gains Worksheet, had him comfortably in the black in his stock sales for the year.

He scratched his head and began to reflect on the year gone by. He had done relatively well investing on his own over the last few years, but closed out 1995 with a resolution to improve his financial state. Sadly, he had taken to holiday egg nog at a Christmas party and had fallen for the pitch of none other than The Churner.

"I'll take that portfolio of yours Dean, and work it like a well-oiled machine."

The words haunted him to this day. All his years of buying and holding blue-chips came to an end as he transferred his discount brokerage account to the Churner's grasping claws on a regrettable January day. His new tobacco-chomping broker sold his holdings and began to trade in and out of speculative penny stocks. With every monthly statement came lower account balances -- along with a greater distaste for "Auld Lang Syne."

The losses were painful enough but now he was dumbfounded to be shelling out even more money to Uncle Sam. Dean was a law-abiding patriot and had no bone to pick with the government. He resisted the urge to write the check in red ink and knew that democracy did not come free. Still, he looked at his Schedule D, and was bewildered.

"One day, this will make sense," he said. On hearing the approach of the postwoman outside the door, he rushed to sign his check and stuff the tax return envelope.

The person delivering Dean's mail had a particular chime to her steps that day. No sooner did he open his door and shout "Outgoing" than he was stopped dead in his tracks by the mail-toting Motli Fool.

She handed him his daily barrage of junk mail (proof that Dick Clark and Ed McMahon were alive and well) and he handed her his return in return.

"You're new to this route aren't you?" he asked.

"Not really."

"I'm sorry, I've just had a long day. . . a long year actually."

She felt his pain. She knew the complexion of perplexion. Before he could begin to vent his displeasure she raised a finger to her lips. There was a perfectly good explanation and Motli knew that Bust the Tipsters readers had no need to go through a second glass of whine.

Why did Dean have capital gains during a year where his portfolio flew South?

1) Dean's portfolio probably did appreciate in 1996; he was simply misreading his brokerage statements.

2) Capital gains are paid on realized gains and losses. Dean probably had large unrealized gains on his years of holding blue chips which Churner sold in early 1996.

3) Capital gains are paid on unrealized gains and losses. While he lost money on Churner's quick-fire trades those he still held at the end of 1996 were profitable.

4) Dean had failed to contribute to his retirement plan before the April 15th deadline.

Enter your selection in the field to the lower right, and get immediate feedback on the answer!

We must, we must, we must increase our busts! The answer is #2.

Churner should no doubt be ashamed of his miserable handling of Dean's portfolio. However, as poor as his trades were, the salt in the wound was the fact that he sold off Dean's original portfolio. That turned Dean's accumulated paper profits -- unrealized capital gains -- into realized capital gains. So, while there were losses from some of the penny stock sales throughout the year (and, win or lose, Churner was always there to collect his commissions) they were not enough to offset the large amount of capital gains from Dean's blue chip sales.

A bit smarter on tax code, and longing for an account transfer form, he thanked Motli as she walked away. He managed a smile, the first one he had mustered in months, and raced to his computer to check out the new and improved Fool website.

© Copyright 1995-2000, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. The Motley Fool is a registered trademark and the "Fool" logo is a trademark of The Motley Fool, Inc. Contact Us