Claiming Capital Losses on Your Tax Return

You Can Deduct Capital Losses Subject to Certain Rules

You incur a capital loss when you sell an investment asset, such as a stock, bond, mutual fund, and you have a negative profit. The sales price is less than what you paid to acquire it. Capital losses on the sale of investment property are tax deductible, although losses resulting from the sale of personal property are not. Numerous rules apply.

Capital Losses Offset Capital Gains

Let's say you sold two investments last year. You bought one stock at $850, which you later sold for $1,000, so you made a profit of $150. You also bought stock in another company at $800, which you later sold for $750, so you lost $50 on this second investment.

The loss on the second transaction can be subtracted from your profit on the first transaction, offsetting it. Your taxable income from the two transactions works out to $100—$150 less $50. The $50 loss on the second investment sale has reduced or offset the profit on the first investment sale. 

Description of property Date acquired Date sold Proceeds Cost or other basis Gain or (loss)
100 sh UVW 1/2/2020 6/30/2020 $1,000 $850 $150
50 sh XYZ 2/13/2020 9/15/2020 750 800 –50
Net gain subject to tax         $100

Effect of the Holding Period

It gets a little more complicated from here because income from capital gains is taxed at different rates depending on how long you hold the asset.

Assets owned for one year or less are short-term holdings, and gains from short-term investments are taxed at less advantageous ordinary income tax rates.

You would have a long-term holding if you owned the shares for more than one year. Gains from long-term investments are taxed at special capital gains tax rates of 0%, 15%, or 20%. The 20% rate affects only the highest earners.

All gains and losses from short-term transactions are added together to determine the net amount of short-term gain, or the short-term loss if the amount of income is negative. Similarly, all gains and losses of long-term transactions are combined to find the net amount of long-term gain or loss. 

Now let's say that you have four transactions ending in the current year. Two have short-term holding periods and the other two have long-term holding periods. The situation would break down like this:

Description of property Date acquired Date sold Proceeds Cost or other basis Gain or (loss)
100 sh UVW 1/2/2020 6/30/2020 $1,000 $850 $150
50 sh XYZ 2/13/2020 09/15/2020 750 $800 $–50
Net short-term gain subject to tax:         $100
           
200 sh QRST 1/2/2018 7/14/2020 $10,000 $15,000 –5,000
350 sh MNOP 2/28/2017 11/20/2020 20,000 $11,000 $9,000
Net short-term gain subject to tax:         $4,000

Overall Capital Losses

You have an overall loss that can be deducted against your other income when your short-term gains or losses plus your long-term gains or losses result in a loss when added together. There are limits on how much of a loss you can claim, however, and when you can do so. 

The long-term loss reduces the short-term gain so you're taxed on only $500 of positive income if you have a net short-term gain of $1,000 and a net long-term loss of $500. The short-term loss would reduce the long-term gain so you would be taxed on only $1,500 of positive income if you had a net short-term loss of $2,000 and a net long-term gain of $3,500.

Finally, if you had a net short-term loss of $2,000 and a net long-term loss of $2,000, the short-term loss and the long-term loss would combine to an overall loss of $4,000. This is the amount that can be used to reduce other income on your tax return...but not all at once. 

Limitations on Overall Net Losses

You're limited to $3,000 per year in net capital losses that you can deduct from your other income, but this doesn't mean that any losses over this amount are wasted. The remainder can be carried over to following years and can be applied to gains and income at that time.

There's no limit to the number of years you can carry over a loss. You can stretch it out over five years if you realize $15,000 in losses. 

This $3,000 limit applies to taxpayers who use the single, head of household, married filing jointly, or qualifying widow/widower filing statuses. Married people filing separate returns are limited to $1,500 per person on net capital losses.

Now let's say you have five transactions:

Description of property Date acquired Date sold Proceeds Cost or other basis Gain or (loss)
100 sh UVW 1/2/2020 6/30/2020 $1,000 $850 $150
50 sh XYZ 2/13/2020 9/15/2020 $750 $800 $–50
Net long-term gain or loss:         $100
           
200 sh QRST 1/2/2018 7/14/2020 $10,000 $15,000 –5,000
350 sh MNOP 2/28/2017 11/20/2020 $20,000 $11,000 $9,000
400 sh IJKL 3/15/2019 12/28/2020 $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 

A loss retains its original classification as long-term or short-term when it's carried over to future years. This means that a short-term loss can only offset other short-term losses. The same rule applies to long-term losses. But any leftover long-term losses can then be applied to short-term gains.

How to File and Claim Losses

Claiming capital losses requires filing IRS Form 8949, "Sales and Other Dispositions of Capital Assets," with your tax return, in addition to Schedule D, "Capital Gains and Losses."

Form 8949 is intended to assist the IRS in comparing information submitted by brokerage and investment firms with that which is included on your tax return.

The Wash Sale Rule

Losses are suspended under what's known as the wash sale rule if you buy "substantially identical" stock or securities within 30 days before or after you sell a stock at a loss. This rule prevents you from claiming the entire loss amount. 

Suppose you sell your stock in XYZ company at a loss on March 31. You have a wash sale situation if you bought the stock in XYZ company 30 days before this date or purchased the same stock up until 30 days after this date.

In this example, your wash sale period runs from March 1, or 30 days before, to April 30, which is 30 days after. You would not be able to claim the full amount of the loss from the March 31 sale if you were to buy XYZ stock at any point during this time frame. You would have to take the loss amount and add it to your cost basis in the new shares you purchased instead. 

Speak with a financial adviser if you find yourself tempted to buy and sell similar stocks within a short period of time.

It's sometimes possible to reinvest in different assets within the same sector, however, particularly when they have a different ticker symbol. The wash sale rule applies to identical assets. 

NOTE: Tax laws change periodically and you should always consult with a tax professional for the most up-to-date advice. The information contained in this article is not intended as tax advice and it is not a substitute for tax advice.