Can Capital Losses Offset Dividend Income?

Capital losses result from the sale of a capital asset for less than the basis. For example, if you buy stock for $1,000 and after holding it for two years you sell the stock for $500, you have incurred a $500 capital loss. In contrast, if you buy the stock for $1,000 and after holding it for two years you sell it for $3,000, you have earned a capital gain of $2,000.

Capital gains are taxable. The rate imposed depends on whether the gain is considered long or short-term. The threshold for long-term capital gains is one year. If you earn a short-term capital gain by selling an asset you have owned for less than one year, the amount gained will be taxed at the same rate as your ordinary income (wages, for example.) However, if you earn a long-term capital gain by selling an asset you have owned for more than one year, the amount gained is taxed at a lower rate, which currently won’t exceed 20 percent.

How do I offset gains with losses?

First, consider the total capital gains and losses incurred in the relevant tax year. Remember that capital gains and losses come from selling capital assets, including stocks, bonds, and property (both personal and investment property qualify.)

If you sell several assets and incur $10,000 in capital losses and $20,000 in capital gains, the amount of the gain that is subject to taxation is reduced by the amount of the capital loss. But suppose that you have $30,000 in capital losses and $20,000 in capital gains. First, you won’t pay capital gains taxes on the $20,000 you gained.

Also, you still have $10,000 in losses to use in a manner that positively affects your tax obligations. If you have no other gains in that year to offset, you can offset $3,000 of other income. The $3,000 may include dividend income as well as wages or other taxable income. If you had dividend income of more than $3,000, you would owe taxes on the amount over $3,000.

What is a wash sale?

A wash sale refers to an investor selling stocks at a loss and purchasing the same (or even a substantially similar) stock within 30 days before or after the sale. The IRS considers this tactic a means of engineering losses and does not allow the investor to use the loss to offset gains.

How is dividend income taxed?

Some dividend income is taxable at the ordinary income rate, while most of such income is taxable at the capital gains rate. The difference is whether the dividend is qualified or not. Most dividends from US-based companies (and some foreign corporations) are qualified and taxed at capital gains rate as long as the investor has owned the shares during the 60-day qualifying period (before the dividend is announced) and has not hedged their position during that time.

What about the balance of capital losses I could not offset?

If you have higher capital losses than gains, and you use $3,000 to offset ordinary income and still have losses remaining, you can carry them forward. You can then use these carryover losses to offset capital gains in another tax year. Remember that all capital gains and losses realized in a tax year must be reported on your tax return using IRS Form 8949.