What is a capital loss?

A capital loss happens when you sell something for less than what you paid for it. This thing you sell is called an asset. An asset can be stocks, bonds, property, or other investments. The difference between the price you paid and the price you sold it for is your capital loss.

Let’s say you buy a stock for $100. Later, you sell that same stock for only $80. You have a capital loss of $20.

Capital losses can help you pay less in taxes. They can cancel out capital gains. Capital gains are when you make money from selling an asset. If your losses are more than your gains, you might be able to use some of the extra loss to pay less tax that year. If you have even more losses, you can sometimes use them to pay less tax in future years too.

An example of a capital loss

Imagine you buy 100 shares of ABC Company stock at $50 per share. That means you paid $5,000 for those stocks ($50 x 100 shares = $5,000).

A year later, ABC Company isn’t doing so well. Their stock price has gone down to $30 per share. You decide to sell your 100 shares at this new lower price of $30. When you sell, you get back $3,000 ($30 x 100 shares = $3,000).

Your capital loss is $2,000. That’s the difference between the $5,000 you paid and the $3,000 you got back when you sold ($5,000 – $3,000 = $2,000 capital loss).

How capital losses affect your taxes

Capital losses can be really helpful when it’s time to do your taxes. They can make your tax bill smaller. Here’s how it works.

Offsetting capital gains

First, your capital losses can cancel out your capital gains. Let’s go back to our example from before. You had a $2,000 capital loss from your ABC Company stocks.

Now let’s say that same year, you also had a capital gain. You sold some XYZ Company stock and made $1,000.

At tax time, you can use your $2,000 capital loss to completely cancel out your $1,000 capital gain. Instead of owing taxes on that $1,000 gain, you now owe nothing. And you still have $1,000 of capital loss left over ($2,000 loss – $1,000 gain = $1,000 loss remaining).

Deducting from your income

If you have more capital losses than gains, you might be able to deduct some of those losses from your regular income. The IRS lets you deduct up to $3,000 of net capital losses each year.

In our example, you had $1,000 of capital loss left over after cancelling out your capital gain. You can deduct that $1,000 from your other income when you file your tax return.

Let’s say your regular income from your job that year was $50,000. You can deduct your $1,000 capital loss from that $50,000. Now, for tax purposes, it’s like you only made $49,000. You’ll probably owe a bit less in taxes because of this.

Carrying over losses to future years

What if you have a really big capital loss that’s more than $3,000? You’re in luck. The IRS lets you carry over any unused losses to future years. You can keep deducting up to $3,000 per year until you’ve used up all your carried-over losses.

Imagine you have a terrible year in the stock market. You sell a bunch of stocks for a total capital loss of $10,000. You have no capital gains to offset.

The first year, you deduct $3,000 of that loss from your regular income. That still leaves you with $7,000 of unused loss ($10,000 – $3,000 = $7,000).

The next year, you can deduct another $3,000. Now you have $4,000 left ($7,000 – $3,000 = $4,000).

The year after that, you deduct another $3,000, leaving you with $1,000 ($4,000 – $3,000 = $1,000).

In the fourth year, you can deduct that final $1,000. It took four years, but you were finally able to deduct that whole $10,000 loss.

Important things to remember about capital losses

There are a few key things to keep in mind about capital losses:

1. Capital losses only happen when you sell an asset, not just when it loses value. If your stock goes down but you don’t sell it, you don’t have a capital loss yet.
2. You have to report all your capital gains and losses to the IRS. There are special forms for this.
3. The rules for deducting capital losses can be tricky. It’s a good idea to get help from a tax professional if you have a complex situation.
4. You can’t deduct losses from selling personal property, like your car or your house. Capital losses only apply to investment property.
5. If you sell an asset to a family member or someone close to you, the IRS might not let you deduct the loss.