A person’s gross income is used to determine how much they have to pay toward federal and state income taxes.
What is a capital loss?
A capital loss occurs when you sell a security or investment for less than the original purchase price or its adjusted basis. Taxpayers can use capital losses on their taxes to offset their capital gains. Capital losses in excess of capital gains can offset taxable income.
The IRS allows capital losses on property held for investment purposes. Property held for personal use is not eligible. Individuals who have capital losses use IRS Form 8949 to report these losses.
There are short-term and long-term capital losses. If you own an investment for less than a year, this is a short-term capital loss. When you own an investment for more than a year, this is a long-term capital loss. For tax purposes, the IRS treats long-term and short-term capital losses the same.
If your capital losses exceed your capital gains, you’re permitted to use $3,000 of the capital loss to reduce your overall taxable income. You can even carry over the remaining capital loss to subsequent tax years.
It is important to note that you can’t take the capital loss until you have sold the asset. Even if your investment dips in value, you have to sell the property to take the capital loss.
Capital loss example
Taxpayers can and should use capital losses to reduce their overall tax obligation.
Assume that you purchased $10,000 in stock two years ago. Now, the stock is only worth $5,000.
You decide to sell the stock for $5,000 and incur a $5,000 capital loss. In the same tax year, you sell stock you purchased three years ago for a $1,000 gain.
You can use $1,000 of the capital loss to offset the capital gain. This leaves $4,000. Of this $4,000, use $3,000 to reduce your taxable income. This leaves $1,000 that you can carry over to the next tax year.
Ready to reduce your income tax obligation? Check out Bankrate’s tax calculators for all your tax-planning needs.