Capital losses occur when you sell a capital asset (think stocks, bonds, or investment real estate) for less than what you bought it. The IRS does allow you to take that capital loss and apply it on a dollar-for-dollar basis against capital gains. The limit on this deduction is $3,000 (if married, filing jointly) or $1,500 (if you’re a single filer).
But how does a short-term capital loss apply to such gains?
To answer this question, let’s define short-term capital loss. Similar to capital gains, capital losses are either short term or long term, based on the following:
When dealing with capital gains, a short-term capital gain is taxed as ordinary income. Meanwhile, a long-term capital gain is taxed at the capital gains rate. But using capital losses to offset gains is somewhat different.
While you can certainly use your short-term capital loss to offset any gain, there’s a certain order when it comes to doing so. Specifically, your short-term losses must first be used to offset any short-term gains (long-term losses offset long-term gains). Once short-term gains are offset, you can use that short-term loss against long-term gains. After that, you can use the short-term loss against ordinary income.
For example, let’s say you generate the following in the same year:
Here’s how you’d offset the above:
Remember that this amount is taxed at the ordinary income rate, as per the rules of short-term gains. Also remember that the overall amount you can deduct can’t exceed $3,000 in a tax year ($1,500 for single filers). These are carried over.
Also remember to report that capital loss on Form 8949 when tax time rolls around. The amount you list on this form is then carried over to your Schedule D/Form 1040.
If you’re dealing with only a couple of short-term losses and gains, the deduction process can be straightforward. This becomes more complex if you’re selling several capital assets at varying times—or if you’re participating in a tax loss harvesting strategy. As such, it’s a good idea to consult with your accountant for advice on deducting short-term capital losses.