If you have lost money on stock investments, you may be able to use all or a portion of the loss as a tax deduction. The Internal Revenue Service has specific rules on how stock losses can be used to lower your income tax bill when you file your return. First, determine the type of loss you have, then calculate how much of the loss can be deducted.
In tax law, “realized” losses and gains refer to investment losses or profits that can be used on your taxes. A loss on stock is not realized unless you have sold the shares. If your stock shares went down $10,000 in value and you did not sell the shares by the end of the year, you do not have a loss that can be deducted. Furthermore, you cannot sell the shares to book the loss and then buy them right back. If you repurchase shares that you sold within 60 days, the transaction is called a “wash sale” and the loss will be disallowed for tax purposes.
Capital Gains and Losses
Another important term in tax law is “capital gains.” You realize capital gains if you sell stock or other assets at a profit. If you sell a stock at a loss, you have a capital loss. You can only claim a tax deduction if the asset was owned for investment purposes. Stock losses are nearly always deductible because stock is universally regarded as an investment. Capital gains and losses are either short-term or long-term – the former applies to stocks owned for less than a year, and a long-term gain or loss occurs if the stock was owned for more than one year before being sold.
Claiming Capital Losses
Capital losses from the sale of stock are claimed on Schedule D, which is attached to your Form 1040 tax return. Capital losses offset capital gains of the same type, then capital gains of the other type, and then other income. So, if your stock loss is a short-term loss, it first offsets your short-term gains for the year. Any remaining short-term loss would then be used to offset long-term gains. Finally, if your loss from the sale of stock was greater than the total of your combined long- and short-term capital gains, up to $3,000 in capital loss can be used as a deduction against other income.
If your stock losses exceed your capital gains by more than the $3,000 limit that you can claim as a tax deduction, you can carry the remaining losses forward to future tax years. The loss can be used against capital gains and up to $3,000 of other income each year until the entire loss has been used to reduce your taxable income and income taxes for the year.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.