Capital losses can decrease income, which ultimately can decrease your tax bill. The gain is reduced when a capital loss is applied to a capital gain. When the gain is less than the capital loss, it can result in an overall capital loss. This loss can then be applied to other income.
We’ll go through a few examples of what capital losses look like and how they offset income.
What Is a Capital Loss?
A capital loss is a loss on a capital asset such as stocks, bonds, mutual funds, or investment real estate. Unlike capital gains, tax rates don’t apply to capital losses since there is nothing to tax. However, short and long-term holding periods still apply.
As a refresher, a short-term holding period is up to one year. A long-term holding period is one year or more.
For example, if you bought a stock on February 1, 2020, the holding period would begin on February 2, 2020. If you sold the stock on February 1, 2021, you would have a short-term gain/loss since the holding period was one year.
However, if the stock was sold on February 2, 2021, you would have a long-term holding period.
When declaring a loss, losses of the same holding period are deducted first. A short-term loss is deducted from a short-term gain. A long-term loss is deducted from a long-term gain. After that, losses can be deducted against other income.
On a yearly basis, up to $3,000 (individuals and married filing jointly) in capital losses can be used to offset other income or $1,500 for married filing separately. Any loss over the $3,000 limit can be rolled over into the next year’s tax return.
Examples of Capital Losses
The best way to see how capital losses offset income is with examples. Let’s go through a few.
Example 1:
Short-term gain: $3,000
Long-term gain: $5,000
Long-term loss: ($7,000)
The long-term holdings first offset each other:
$5,000
($7,000)
= ($2,000)
The $2,000 long-term loss can be applied to the $3,000 short-term gain for a total short-term gain of $1,000. Because this is a short-term gain, regular income tax rates will apply to the $1,000 gain.
Example 2:
Short-term gain: $5,000
Short-term loss: ($9,000)
This investor has a short-term loss of $4,000. $3,000 of this loss is applied to current year income. The $1,000 remaining loss is carried over into the next year.
Let’s say this investor has a $3,000 gain for the next year. Once the $1,000 carryover loss is applied, the net gain is $2,000. Any other losses during the same year can be applied to income.
If the investor had $5,000 in capital losses, applying $2,000 of the $5,000 loss to the remaining $2,000 gain nets a loss of $3,000. This $3,000 is the annual limit and can be used to offset other income. In this case, all capital losses have been used, and there is no carryover.
Capital losses are used to offset capital gains. Losses that remain after capital gains have been offset can be used against other income. Any loss remaining over $3,000 can be carried over into the next year. The carryover loss can be used for up to seven years until it is exhausted.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor.
Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation.
Hypothetical examples are for illustrative purposes only.
