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When you sell a winning investment, you're on the hook for capital gains taxes. Can you claim a capital loss when you sell an investment for less than you paid?
You can. Capital losses are deductible on your tax return, and you can use them to reduce or eliminate capital gains or to reduce ordinary income up to certain limits. Here's how a capital loss can impact your taxes in the current year—and into the future.
What Is a Capital Loss?
Capital losses occur when you sell an investment for less than you paid for it. For tax purposes, a capital loss only counts if it's realized—that is, if you sell the investment. If your investments drop in value but you hold on to them, your unrealized "loss" doesn't affect your taxes.
The following capital loss rules apply to investments like stocks, bonds, mutual funds, cryptocurrency and real estate. They don't apply to personal-use items like your car or home.
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How to Deduct Capital Losses on Your Tax Return
Recognizing a capital loss is part of the normal process of calculating capital gains taxes on your tax return. Follow these basic steps to figure out your long-term and short-term capital gains and losses.
- Review your gains and losses for the year. You can find these details on IRS Form 1099-B or 1099-S. If you work with more than one investment company, broker or financial institution, you may have more than one 1099.
- Categorize your transactions. Use Form 8949 to divide your transactions into long-term gains, short-term gains, long-term losses or short-term losses. A long-term investment is one that's held for more than a year according to the IRS.
- Use Schedule D on Form 1040. Subtract long-term losses from long-term gains and short-term losses from short-term gains.
- Determine your net loss. Reconcile long- and short-term gains and losses to get a single net gain or loss.
Using Capital Losses to Offset Gains or Income
You can determine how your capital gains or losses will affect your taxes this year and even possibly in upcoming years. Say, for example, you have the following capital gains and losses for 2021:
- Short-term gain = $0
- Short-term loss = $20,000
- Long-term gain = $8,000
- Long-term loss = $1,500
In this example, you show a short-term loss of $20,000 ($0 - $20,000) and a long-term gain of $6,500 ($8,000 - $1,500). Netted against each other, your gains and losses result in a net loss of $13,500, which eliminates your $6,500 taxable long-term capital gain for 2021.
In this example, you can deduct your net loss of $13,500—but not all at once. The IRS allows you to deduct up to $3,000 in capital losses from your ordinary income each year—or $1,500 if you're married filing separately. If you claim the $3,000 deduction, you will have $10,500 in excess loss to carry over into the following years.
You can claim up to $3,000 of this money per year against ordinary income until your excess is gone. You can also use this carryover deduction to reduce any capital gains in future years. So, if you realized $10,500 in capital gains in 2022, your excess contributions can reduce your capital gains tax liability to $0.
Capital Gains Rules to Remember
Here are a few rules to consider as you calculate, claim or carry over a capital loss:
- There's no restriction on how much loss you can claim to offset capital gains. If you have $8,000 in capital gains and $5,000 in capital losses, you can subtract the full $5,000 from your capital gain.
- You can only apply $3,000 of any excess capital loss to your income each year—or up to $1,500 if you're married filing separately.
- You can carry over excess losses to offset income in future years. The same $3,000 (or $1,500) limit applies.
- You can also use excess capital loss to reduce your capital gains in future years. The $3,000 limit does not apply.
Taking the Sting out of a Losing Investment
Using a capital loss to reduce your tax bill can take some of the sting out of losing money on an investment—although, of course, having a loss is never the best possible outcome. If you're thinking about "harvesting" losses to lock in a tax deduction, be strategic: You must wait more than 30 days to repurchase the same asset if you want to deduct your capital loss, which could mean selling low and buying high—the opposite of what you strive for as an investor. At the same time, capital loss deductions are useful when saving money on your taxes is the next best thing to making money on your investments.