The Internal Revenue Service taxes stock market gains, but only to the extent they exceed your losses in a given year. However, the IRS does not recognize any stock market gains or losses until you actually sell. At that point, you compare the price of the security when you sell it against the price you bought it at. If it's higher, you realize a gain.
Short-Term vs. Long-Term Capital Gains
If you sell the stock less than 12 months after you bought it, it's a short-term gain. If the price is lower, you have realized a loss. If it's been longer than 12 months, it's a long-term gain. Short-term and long-term losses are defined the same way. You can generally deduct losses up to the amount of your gains, plus $3,000 in any given year.
Taxation of Capital Gains
The tax on short-term capital gains is generally the same as your individual marginal income tax rate. Under current tax law, which is scheduled to continue through 2012, that is always higher than the tax on long-term capital gains, which is 0 percent for the 10 percent and 15 percent tax brackets, and 15 percent for everyone else.
Tax Loss Harvesting
You can deduct an unlimited amount in losses by realizing an equal amount of capital gains. For example, if you have $20,000 in capital gains in a given year, you can sell as many losing stocks as you have until you have realized $20,000 in losses. This technique is called "tax loss harvesting," and when executed properly, with enough losing stocks to sell, you can potentially cancel out your capital gains tax liability.
Deducting Stock Market Losses Against Income
You may deduct up to $3,000 in losses against income each year. You may carry forward losses an unlimited number of years. For example, if you realize $12,000 in stock market losses, you can carry forward your losses for up to four years, deducting $3,000 of income each year.
Wash Sale Rules
If you claim a capital loss deduction, you may not purchase that security or a substantially identical security, including a mutual fund share, for a period of 30 days. Otherwise, the IRS may disallow your capital loss deduction.
You may deduct the cost of investment newsletters, commissions and investment advisory fees.
Claiming the Deduction
Claim the deduction by attaching a copy of Schedule D, Capital Gains and Losses, to your individual income tax return. You can find a copy of the form in Resources.
Jason Van Steenwyk has been writing professionally since 1998. A former staff reporter for "Mutual Funds Magazine," he has been published in "Wealth and Retirement Planner," "Annuity Selling Guide," "Registered Rep." "Bankrate.com" and "Senior Market Advisor." He holds a Bachelor of Arts in humanities from the University of Southern California.