Can a Capital Loss Carry Over to the Next Year?
Here's how tax losses carry forward to future years
Investors hope for capital gains, but taking a capital loss isn't necessarily the worst thing that can happen, either. A capital loss deduction can be used on your tax return to reduce what you owe the IRS, and it can carry forward to following years if it's not all used up in the current year.
The Definition of a Capital Loss
A capital asset is anything you purchase and own for personal or investment purposes. You would have a capital gain or a capital loss if you should later sell that asset for more or less than your basis in it—what you paid for the asset plus certain allowable costs. The difference between what you paid for the asset and the ultimate sales price represents either a capital gain or a loss.
You would have a $5,000 capital loss if you purchased an asset for $50,000 and invested $10,000 into maintaining it, then sold the asset for $55,000. You've lost $5,000: $50,000 plus $10,000 is $60,000, but you sold it for $55,000, or $5,000 less than your total investment.
Use Losses to Offset Capital Gains
Let's assume that you have a $5,000 capital loss, and you also have a $5,000 capital gain on the sale of another investment. The gain and the loss would offset each other on your return. You would have no tax loss remaining to carry over to the next year in this situation.
You can't choose to pay tax on the gain this year and roll over the loss to the following year, and capital losses must first be used to offset any capital gains of the same type in the current tax year before they can be rolled over to the next.
Use Losses to Offset Ordinary Income
There's a $3,000 cap on how much of your loss you can use to offset ordinary income.
You can deduct $3,000 of the capital loss from your ordinary income if you have a $5,000 loss and no gains. You would only pay tax on $47,000 of your ordinary income if your ordinary income was $50,000.
The remaining $2,000 of your total $5,000 loss can be carried forward to future years.
Each spouse can deduct only $1,500 against ordinary income if you're married and file separate married returns.
Carrying Over Losses—An Example
Let's assume the stock market has a bad year. You sell a stock or mutual fund and realize a $20,000 loss. You have no capital gains that year.
- First, you'll use $3,000 of the loss to offset your ordinary income. The remaining $17,000 will carry over to the following year.
- Next year, if you have $5,000 of capital gain, you can use $5,000 of your remaining $17,000 loss carryover to offset it. You can use another $3,000 to deduct against ordinary income, leaving you with $9,000.
- That remaining $9,000 will then carry forward to the next tax year.
- Assuming you had no capital gains in the following three years, you could use up the remaining $9,000 loss $3,000 at a time over those three years.
How to Claim a Loss
Capital gains, capital losses, and tax loss carry-forwards are reported on IRS form Schedule D, or Form 8949 for real estate or business investments. When reported correctly, these forms will help you keep track of any capital loss carryover.
Your total net loss appears on line 21 of the 2019 Schedule D and transfers to line 6 of the 2019 Form 1040 that you'll file in 2020. You can carry forward any excess over the $3,000 or $1,500 limits. The IRS offers a Capital Loss Carryover Worksheet in Publication 550 for guidance.
The 2018 and 2019 Forms 1040 are markedly different, and they're different from previous tax years as well. The IRS redesigned the form for both years. These lines and instructions pertain only to the 2019 return.
When to Realize a Capital Loss
Sometimes it makes sense to realize a capital loss on purpose so you can use it to offset capital gains and ordinary income in future years. This concept is referred to as "tax-loss harvesting" and is used by savvy investors.
Ordinary income is taxed at a higher rate than long-term capital gains, so realizing a loss and carrying your capital loss forward so $3,000 of it can offset ordinary income each year can mean a lower tax bill for you. Having less ordinary income can also mean less of your Social Security benefits are taxable for the year if you're retired.
The effectiveness of tax-loss harvesting is largely debated in academic circles, but most agree that certain people see more benefits from it than others based on their tax situation.
Don't enter into a tax-loss harvesting strategy without first consulting with a tax professional.
Additional Rules and Changes
These gain and loss rules apply primarily to publicly traded investments, such as stocks, bonds, mutual funds, and in some cases, real estate holdings. Capital loss carryovers do not apply to assets held for personal use.
There are additional rules that apply when you realize both short-term gains vs. long-term gains, whether deductions can be used to offset state income, how real estate gains are treated when you must recapture depreciation, and how you account for passive losses and gains.
The 2018 tax year saw a lot of changes based on the Tax Cuts and Jobs Act (TCJA), including giving long-term capital gains their own tax brackets and indexing them for inflation. You might consider seeking the advice of a tax professional as these changes take effect and if you have investment income or losses.
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