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Claiming Capital Losses on Your Tax Return

Capital losses occur when you sell an investment asset – such as stocks, bonds, or mutual funds – and lose money. The selling price is less than what you paid to acquire it. Capital losses on the sale of investment properties can be deducted from taxes; however, losses from the sale of personal property cannot be deducted.

How can I use capital losses to offset capital gains?

If you have both capital gains and losses, you can use the losses to offset the gains. You can subtract the value of the losses from the value of the gains. This will act as a deduction that can reduce your taxable income.

Let’s assume you sold two investments last year. You bought one share for $850 and later sold it for $1,000. This means you made a profit of $150. You also purchased shares in another company for $800 and sold them later for $750. This means you lost $50 on the second investment.

You can subtract the loss from the second transaction from the profit from the first transaction, thus offsetting it. Your taxable income from the two transactions would be: $150 – $50 = $100. The loss of $50 from the sale of the second investment reduced the profit from the sale of the first investment.

What is the holding period for capital losses and gains?

Dealing with capital losses and gains can be a bit complex. This is because income from capital gains may be taxed at different rates. The tax rate depends on how long you have held the asset.

Assets you hold for one year or less are considered short-term assets. Profits from short-term investments are taxed at the same rate as regular income.

You will have a long-term investment if you hold the shares for more than one year. Profits from long-term investments are taxed at special capital gains tax rates of 0%, 15%, or 20%. The 20% rate only affects high-income earners.

Note: Profits from the sale of collectibles may be taxed at rates up to 28%, and profits from the sale of real estate under Section 1250 may be taxed at rates up to 25%.

When using capital losses to offset capital gains, you must group the losses and gains by their holding periods. Short-term capital losses can only be used to offset short-term capital gains. Long-term capital losses can only be used to offset long-term capital gains.

What can I do with overall capital losses?

Sometimes, a combination of short-term gains or losses along with long-term gains or losses results in an overall loss. When this happens, you have an overall loss that can be deducted from other income. There are limits on how much loss you can claim and when you can do so.

You can use overall capital losses to reduce your taxable income by up to $3,000 or the amount shown on line 16 of Schedule D, whichever is less. If your losses exceed this amount, you can carry over the remaining loss to the next tax year or several years. For example, if you had $15,000 in losses, you could reduce your taxable income by $3,000 annually for the next five years.

These $3,000 limits apply to taxpayers using the single, head of household, or married filing jointly status, or qualifying widow(er). Married individuals filing separately are limited to $1,500 each on net capital losses.

Note:

Long-term or short-term losses carry over into future years. This means that short-term losses can only offset other short-term losses. The same rule applies to long-term losses, but any remaining long-term losses can then be applied to short-term gains.

How do I report and request losses?

To request capital losses, you must file IRS Form 8949 “Sales and Other Dispositions of Capital Assets” with your tax return. You will also need to submit Schedule D “Capital Gains and Losses” with your Form 1040.

Note: Form 8949 aims to help the IRS compare the information provided by brokerage and investment firms with what you report on your tax return.

What is the wash sale rule?

Losses are subject to what is known as the “wash sale rule” if you buy “substantially identical” stock or securities within 30 days before or after selling a stock at a loss. This rule prevents you from claiming the full amount of the loss.

For example, if you sold your shares in XYZ Corp at a loss on March 31, you would have a wash sale if you purchased shares of XYZ Corp within 30 days before that date or the same shares up to 30 days after that date.

In this example, your wash sale period would be from March 1 (30 days before) to April 30 (30 days after). You would not be able to claim the full amount of the loss on the March 31 sale if you purchased XYZ shares any time during that time frame. You would have to take the amount of the loss and add it to the cost basis in the new shares you bought instead.

Sometimes it is possible to reinvest in different assets in the same sector, especially when they have a different identification code. The wash sale rule applies to substantially identical assets.

If you are considering buying and selling similar shares in a short time frame or are unsure if your investment actions will be subject to the wash sale rule, consult a financial advisor before making any decisions.

Source: https://www.thebalancemoney.com/capital-losses-3193426


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