Financial Terms / C - D / Capital loss

What is a capital loss?

A capital loss happens when you sell a capital asset for less than you bought it. Capital assets are important things you own, like homes, cars, stocks, bonds, and even collectibles or art. For businesses, capital assets are things that help make money and last longer than a year.

When you sell a capital asset and lose money, you have a capital loss. This is the opposite of a capital gain, which happens when you sell an asset for more than you paid. It's important to know that capital losses only count for tax purposes when you actually sell the asset. If the value of your asset goes down but you don't sell it, that's called an unrealized or paper loss.

Not all losses count as capital losses for taxes. For example, if you sell your house or car at a loss, you can't use it as a tax deduction. However, if you sell stocks, bonds, or other investments at a loss, you might be able to use those losses to lower your taxes.

Remember, capital losses can help balance out your capital gains when it comes to taxes. You can use your losses to offset your gains, which might lower your tax bill.

Calculating Capital Loss

To figure out your capital loss, you need to know the difference between what you paid for an asset and what you sold it for. This is called the adjusted basis. The adjusted basis includes the purchase price plus any fees like brokerage costs.

Here's how to calculate your capital loss:

1. Determine the number of shares sold
2. Multiply by the adjusted cost basis per share
3. Subtract the total sale price

Remember, you can only claim a capital loss when you actually sell the asset. If the value drops but you don't sell, it's just a paper loss.

For stocks, you might need to adjust the cost basis if there was a stock split while you owned the shares. For example, in a 2-to-1 split, you'd cut the cost basis per share in half.

When reporting your losses, you'll use Form 8949. Short-term losses (assets held for a year or less) go in Part I, while long-term losses (assets held for more than a year) go in Part II. You'll then combine these on Schedule D to get your total net capital gain or loss for the year.

Tax Implications of Capital Losses

Capital losses can help lower your tax bill. When you sell an investment at a loss, you can use it to offset capital gains. If your losses exceed your gains, you can deduct up to $3,000 from your ordinary income. This applies to single, joint, and head of household filers. For married filing separately, the limit is $1,500.

Short-term losses (assets held for a year or less) offset short-term gains first. Long-term losses offset long-term gains. If you have excess losses of one type, you can apply them to the other. For example, if you have $15,000 in long-term losses but only $5,000 in long-term gains, you can use the remaining $10,000 to offset short-term gains.

Any unused losses can be carried forward to future tax years. This helps spread out the tax benefits of your losses over time. To claim these deductions, you'll need to fill out Form 8949 and Schedule D with your tax return.

Reporting Capital Losses on Tax Returns

To report your capital losses, you need to use Form 8949 and Schedule D with your tax return. On Form 8949, you'll list your short-term losses in Part I and long-term losses in Part II. Then, transfer these totals to Schedule D.

You can deduct capital losses up to the amount of your capital gains plus $3,000 ($1,500 if married filing separately). If your losses exceed this limit, you can carry them forward to future tax years.

Here's how to report your losses:

1. Calculate your net short-term and long-term capital losses separately.
2. Combine these to get your total net capital loss.
3. Enter the smaller of your total net loss or $3,000 ($1,500 if married filing separately) on Form 1040, line 7.

Remember, you can't deduct losses from sales between family members or related parties. Also, be aware of the wash sale rule: if you sell a stock at a loss and buy it back within 30 days, you can't claim the loss for tax purposes.

FAQs

How do you calculate capital losses for tax purposes?

Capital losses are calculated by comparing short-term gains and losses, which are noted on Part I of the tax form to determine the net short-term capital gain or loss. Similarly, long-term gains and losses are reconciled on Part II to compute the net long-term capital gain or loss.

Can a $3,000 capital loss be deducted from your taxes?

Yes, you can deduct up to $3,000 of capital losses against your ordinary income as per the rules in IRC Section 1211(b). If your losses exceed $3,000, the excess amount cannot be used in the current tax year but may be carried forward to future years.

Is it possible for capital losses to reduce ordinary income?

Yes, capital losses not only offset capital gains but can also reduce up to $3,000 of ordinary income per year. This makes them a useful tool for lowering your overall tax liability.

What are some examples of capital losses?

A capital loss occurs when the sale price of a capital asset is less than its purchase price. For instance, if someone buys a house for $250,000 and later sells it for $200,000, they incur a capital loss of $50,000. This loss can be used to offset capital gains for tax purposes.