The Internal Revenue Service (IRS) requires a taxpayer to claim any money he makes from the sale of a capital asset on his federal tax return. Similarly, the IRS expects an individual to record a loss incurred through the sale of a capital asset. If a person’s capital loss exceeds his capital gain, the IRS permits the individual to incrementally reduce his other income by the amount of the loss over a period of time.
The IRS views capital assets as either short term or long term. The IRS labels assets owned for one year or less as short term. The IRS taxes short-term gains as income.
Subtracting short-term losses from short-term gains reduces or eliminates the amount of tax a person owes from the sale of a short-term holding. If a person’s short-term loss exceeds the amount of his short-term gain, the IRS allows him to apply the loss against his long-term gains, if any exist.
The IRS considers a capital asset long term if it belongs to a person for more than a year. The IRS taxes long-term gains at a capital gain tax rate, which is usually 15 percent or less. Depending on the nature of the asset sold, the capital gains tax rate may reach 28 percent, however.
Subtracting long-term losses from long-term capital gains either lowers or eradicates a person’s need to pay taxes on the sale of a long-term holding. The IRS permits excess long-term losses to offset short-term capital gains.
Capital Loss vs. Income
The IRS allows a person to apply capital losses in excess of capital gains to his income. In other words, a person may reduce his taxable income by subtracting up to $3,000 of his capital loss from his income. If a married person files a separate tax return, the IRS limits the amount of capital loss he may use to offset his income to $1,500.
If a person absorbs capital loss in an amount that exceeds his gains and the permissible application against ordinary income, he may carry over the excess and apply it against capital gains and income in the ensuing tax year. If the taxpayer still records a net capital loss, he may carry the balance forward to the next year’s taxes and so on until he uses the loss in its entirety.
For instance, if a person retains a net capital loss of $30,000 after completing his 2010 federal tax return, he may use the loss when completing his 2011 return. If the person receives proceeds of $5,000 from the sale of either a short- or long-term asset and suffers no capital losses in 2011, he eliminates his capital gain tax burden by offsetting the gain with $5,000 of the previous year’s losses. The married person who files a joint return would apply an additional $3,000 of the loss to his income.
The IRS allows the taxpayer to carry the remaining $22,000 of loss forward on subsequent federal tax returns for however many years it takes to exhaust the loss.
Continuing with the example, if the same person does not report any capital gains in the ensuing decade, he would offset his income by $3,000 during each of the following seven years. In the eighth year, he would offset his income by the remaining, $1,000.
- IRS.gov: Reporting Capital Gains and Losses
- IRS.gov; Publication 550 (2010), Investment Income and Expenses; February, 2011
- IRS.gov; Publication 544 Sales and Other Dispositions of Assets; March, 2011
- IRS.gov; Ten Important Facts About Capital Gains and Losses; February, 2011
- Using Long-Term Capital Loss Carryovers; Andrew Chan; April, 2009
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