Capital Losses

To incur a capital loss is to have a negative profit after selling an investment asset such as stocks, bonds, mutual funds, real estate or other capital assets. A loss happens when the money received from selling the asset is less than the amount of money you paid to acquire the asset. If someone buys an asset for $100, and later sell that asset for $90, this person has lost $10.

Or to speak in a more general way, start with the selling price and subtract the original purchase price.

If the resulting answer is a positive number, you have a gain or profit. If the resulting answer is a negative number, you have a loss. Using the above example, 90 – 100 = – 10. Negative ten means we have a loss of ten dollars.

Capital Losses Offset Capital Gains at the Transaction Level

Let us suppose Andrew has sold two investments this past year. He buys one stock at $850, which he later sells for $1,000. Here, he has made a profit of $150. He also bought stock in another company at $800, which he later sold for $750. On this second investment Andrew lost $50. The loss on the second transaction is subtracted from the profits on the first transaction. Andrew's taxable income from these two transactions is 150 – 50 = $100. The $50 loss on the second investment sale has reduced or offset the profits on the first investment sale.

The loss on one transaction directly offsets the gain on the other transaction.

After combining these two transactions, the net result is the amount that is taxable income. We summarize Andrew's situation in the following table:

Example: How capital losses offset capital gains at the transaction level

Description of property

Date acquired

Date sold

Proceeds

Cost or other basis

Gain or (loss)

100 sh UVW

01/02/14

06/30/14

1,000

850

150

50 sh XYZ

02/13/14

9/15/14

750

800

–50

Net gain subject to tax

 

 

 

 

100

 

Capital Losses Offset Capital Gains of the Same Holding Period

Now we need to be a little more precise. Income from capital gains are taxed at different rates, depending on how long the asset was owned. If the asset was owned for more than one year, this is called a long-term holding, and gains from such long-term investments are taxed at special rates of zero percent, 15% or 20%.  Assets owned for one year or less are short-term holdings, and gains from short-term investments are taxed at the regular tax rates ranging from 15% to 39.6%.

Accordingly, we add together all the gains and losses of short-term transactions to find the net amount of short-term gain (or loss, if the amount of income is negative). Similarly, we add together all the gains and losses of long-term transactions to find the net amount of long-term gain (or loss, if the amount is negative).

We combine the above rule (about netting transactions together) with this rule (about keeping transactions separated into short-term and long-term categories). Combined, the two rules fit together like this:

  • Losses on short-term transactions are subtracted from short-term gains to result in a net amount of short-term gain or loss.
  • Losses on long-term transactions are subtracted from long-term gains to result in a net amount of long-term gain or loss.

Another way to phrase this: losses on short-term investments reduce gains made on other short-term investments. And similarly, losses on long-term investments reduce gains made on other long-term investments.

Let's continue the example from above. Now, Andrew has four transactions. Two have a short-term holding period. And another two have a long-term holding period. We organize Andrew's data into the following table:

Example: How capital losses offset capital gains of the same holding period

Description of property

Date acquired

Date sold

Proceeds

Cost or other basis

Gain or (loss)

100 sh UVW

01/02/14

06/30/14

1,000

850

150

50 sh XYZ

02/13/14

9/15/14

750

800

–50

Net short-term gain subject to tax

100

 

 

 

 

 

 

200 sh QRST

01/02/12

7/14/14

10,000

15,000

–5,000

350 sh MNOP

02/28/12

11/20/14

20,000

11,000

9,000

Net long-term gains subject to tax

4,000

 

Overall Capital Losses

When your short-term gains or losses plus your long-term gains or losses, when added up, result in a loss, then you have an overall loss that can be deducted against your other income. 

  • "Net loss.   If the total of your capital losses is more than the total of your capital gains, the difference is deductible. But there are limits on how much loss you can deduct and when you can deduct it" (IRS.gov, Publication 544).

Example 1:

  • Net short term gain: $1,000
  • Net long-term loss: – 500.

Here, the long-term loss reduces the short-term gain, and the person is taxed only on $500 of positive income.

Example 2:

  • Net short-term loss: – $2,000
  • Net long-term gain: $3,500

Here, the short-term loss reduces the long-term gain, and the person is taxed only on $1,500 of positive income.

Example 3:

  • Net short-term loss: –$2,000
  • Net long-term loss: –$2,000

Here, the short-term loss and the long-term loss combine to an overall loss of $4,000. This amount can reduce a person's other income on their tax return. The amount of the overall loss that can be used to reduce other income is limited to a maximum amount, however.

Limitations on Overall Net Losses

We can deduct up to $3,000 per year in net capital losses. If net losses exceed this amount, then $3,000 of the loss is deducted against other income, and the remainder amount carries over to the following year. This $3,000 limit applies to people using the single, head of household, married filing jointly and qualifying widow/widower status. Married people filing separately are limited to $1,500 per person on their net capital losses.

  • "If your capital losses are more than your capital gains, you can deduct the difference as a capital loss deduction even if you do not have ordinary income to offset it. The yearly limit on the amount of the capital loss you can deduct is $3,000 ($1,500 if you are married and file a separate return)" (IRS.gov, Publication 544).

Let's continue the example from above. Let's say Andrew now has five transactions, as follows:

Example: How overall net losses work

Description of property

Date acquired

Date sold

Proceeds

Cost or other basis

Gain or (loss)

100 sh UVW

01/02/14

06/30/14

1,000

850

150

50 sh XYZ

02/13/14

9/15/14

750

800

–50

Net short-term gain or loss

100

 

 

 

 

 

 

200 sh QRST

01/02/12

7/14/14

10,000

15,000

–5,000

350 sh MNOP

02/28/12

11/20/14

20,000

11,000

9,000

400 sh IJKL

03/15/12

12/28/14

5,000

13,000

–8,000

Net long-term gain or loss

–4,000

Overall net capital loss (short-term gain + long-term loss)

–3,900

Amount deductible against other income this year

3,000

Amount of capital loss carried over to next year

–900

Carryover Losses Retain Their Character as Short-Term or Long-Term

  • "… When you carry over a loss, it retains its original character as either long term or short term. A short-term loss you carry over to the next tax year is added to short-term losses occurring in that year. A long-term loss you carry over to the next tax year is added to long-term losses occurring in that year. A long-term capital loss you carry over to the next year reduces that year's long-term gains before its short-term gains."
  • "If you have both short-term and long-term losses, your short-term losses are used first against your allowable capital loss deduction. If, after using your short-term losses, you have not reached the limit on the capital loss deduction, use your long-term losses until you reach the limit." (IRS.gov, Publication 544)

Wash Sale Rule

Whenever a person buys substantially identical stock or securities within 30 days before or after selling stock at a loss, then the losses are suspended under the wash sale rule.

Suppose I sell stock in XYZ company at a loss on March 31st. If I buy the stock in XYZ company 30 days before to 30 days after March 31st, then I have a wash sale situation. For a March 31st selling date, that means my wash sale period runs from March 1st (thirty days before) to April 30th (thirty days after). If I were to buy XYZ stock during this time frame, I would not be able to claim the full amount of the loss from the March 31st sale. Instead, I would take the loss amount and add it to my cost basis in the new shares I purchased.

Further Reading