Losing money on an investment can be difficult to stomach.
Watching the value of your cryptocurrency holdings evaporate like water spilled on hot desert sands, or seeing your once-prized stock in an electric car manufacturer shed value faster than tech companies are shedding jobs may leave your guts in a lurch. These declines in value are considered capital losses if you sell the investments for less than their purchase price.
Fortunately, there’s a bit of a soft landing when it comes to capital losses on crypto, stocks, bonds, mutual funds, and real estate held for investment purposes. You can use capital losses to offset capital gains or lower the amount of ordinary income reported on your Form 1040, which could potentially reduce your tax bill.
Here’s a closer look at how it works.
Realized capital losses – losses on investments you’ve sold – can be used in two ways.
1. You can use capital losses to offset capital gains. Short-term capital losses must be matched against short-term capital gains, and long-term capital losses must be paired against long-term gains. However, if you have excess losses from one category they can be applied to the other. Short-term losses are from assets held less than one year, while long-term losses are for assets held longer than a year.
You’ll need to categorize your different types of capital losses when netting them against capital gains because short- and long-term gains are taxed much differently. You may find a strategic advantage by realizing either type of loss in a given tax year in order to maximize your potential tax savings by minimizing your taxable income.
2. If you have capital losses with no realized capital gains, you can apply those losses against your ordinary income. There’s a limit on capital loss deductions of $3,000 each year, or $1,500 annually for married taxpayers who file separate tax returns. If your net capital losses exceed the annual income deduction of $3,000, you can carry losses forward into subsequent tax years until the amount of loss is exhausted. For example, a net capital loss of $12,000 in one tax year can be applied to four consecutive tax years, provided you have no realized capital gains during that time frame.
You’ll find capital losses from the sale of stocks and similar financial products reported on Form 1099-B. You’ll find capital losses on the sale of investment real estate reported on Form 1099-S.
You’ll use Form 8949 to categorize your short- and long-term capital losses and gains, and you’ll report those amounts on Schedule D on your Form 1040.
You can use capital losses to lower the amount of ordinary income reported on your Form 1040, or to reduce any potential tax liability generated from realized capital gains. If you have no reported capital gains, and the amount of your net capital loss exceeds $3,000, you can roll any additional amount over into the following tax years to lower your ordinary income until all the loss is used.
The ability to deduct capital losses can take some of the sting out of investments that lose money. Discussing your particular tax situation with a certified tax professional can help you determine when it might be best to take a short- or long-term capital loss in a given tax year in order to maximize your potential tax advantages.