What Is a Capital Loss Carryover?
I want you to understand that a capital loss carryover is the process of claiming the balance of a capital loss deduction in future years when it exceeds the annual limit in the first year.
The IRS allows you to claim loss deductions from your annual capital gains when your losses exceed your gains. The amount you can deduct from your other income after eliminating your gains is $3,000.
You don't lose any unused balance of your capital loss because the Internal Revenue Code includes a provision that lets you carry any remaining balance forward for an unlimited number of years until it's depleted. This is what we call a capital loss carryover in tax terms.
Key Takeaways
The Internal Revenue Code lets you claim a capital loss deduction from your annual capital gains. Your capital loss deductions from regular income are limited to $3,000 a year. If your losses go over this limit, you can carry them forward and claim them in future tax years using a capital loss carryover. Remember, the wash sale rule restricts you from selling and rebuying 'substantially identical' stocks and securities to realize a capital loss for future use.
How Capital Loss Carryovers Work
To grasp how a capital loss carryover works, start with the tax rules for capital gains. Gains are either short-term or long-term, and there's a big financial difference between them.
Short-term gains are taxed at the same rates as your ordinary income; these apply to assets you owned for one year or less at the time of sale. Long-term gains are for assets you owned more than one year before selling, and they're taxed at preferential rates: 0%, 15%, 20%, 25%, or 28%. The higher your overall income, the higher your long-term capital gains tax rate up to 20%. The 25% and 28% rates apply only to certain assets.
You calculate your capital gain or loss by subtracting your adjusted basis in the asset from the sale amount. Your adjusted basis is usually what you paid for it plus any maintenance costs.
A capital loss carryover lets you apply any remaining loss balance to your regular income after erasing your capital gains for the year. There's no deadline—you can keep carrying the loss over to your regular income for unlimited subsequent years until it's gone.
A Carryover Example
Let's say you sold an investment for $6,000, but your basis in the asset was $11,000, so you suffered a $5,000 loss.
You can claim that loss on your tax return by subtracting it from your capital gains. But if you only had $1,000 in gains, your $5,000 loss erases that $1,000, leaving you with $4,000 more. You can use up to $3,000 of that to offset your other income in the same year, and carry the remaining $1,000 forward to the next year.
Important Notes on Losses
Losses from selling personal property like your home aren't deductible, and neither are losses from exchanges between certain family members or between corporations and an individual who holds more than 50% of its stock.
A long-term capital loss must be applied to a long-term capital gain first before you can carry it over to a short-term capital gain.
The Wash Sale Rule
Savvy investors know how to use tax laws to their advantage, but the IRS has the wash sale rule to control manipulation of capital losses, especially with stocks or securities.
A wash sale happens when you sell this type of asset and buy a 'substantially identical' stock or security within 30 days before or after the sale. Only professional dealers in stocks and securities can do this.
This is known as tax-loss harvesting, where you aim to get a tax-deductible loss, often at year-end, to offset other gains. But losses from stocks and securities aren't deductible if you buy or acquire an identical one during those 30-day periods.
The disallowed loss gets added to the adjusted basis of the new stock. The wash sale rule also applies to transactions by spouses—you can't buy a substantially identical investment after your spouse sells one within that 30-day period.
Calculating Your Loss Carryover
You have an eligible capital loss carryover if your loss exceeds your gains for the year or your taxable income increased by at least the amount of your capital loss deduction, whichever is less. The IRS provides Worksheet 4-1 in Publication 550 to help you figure it out. You calculate capital losses or gains on IRS Form 8949 with your tax return.
There's a wrinkle for married taxpayers filing separate returns: a capital loss carryover from a joint return can only be deducted by the spouse who had the loss if you're filing separately going forward. Also, the deduction is limited to $1,500 a year or the amount of your losses, whichever is less, if your filing status is married filing separately.
The Bottom Line
No one likes realizing a capital loss on an investment, but it happens. U.S. tax law gives you a break when it does, with numerous rules in place. You're allowed to carry unclaimed losses forward to future years without a limit on the number of years. Long time frames are fine, but very short ones of 30 days before or after selling for a loss can trigger IRS scrutiny and disallow the deduction.
Always consult a professional tax advisor if you're unsure about your timing or want to ensure you're carrying over and claiming the correct amount.
