IRS Rules on Carryover Loss Against Capital Gains

by David Carnes

    Capital gains tax liability is triggered when you make a profit from the sale of a capital asset, which includes nearly every type of property except business inventory and accounts receivable. You incur a capital loss when you sell a capital asset at a loss. Fortunately, capital losses from one transaction can be offset against capital gains tax liability arising from another transaction.

    The IRS allows you to calculate your capital gains based on the selling price minus your “adjusted basis” – typically, the price you paid plus any additional investment, such as improvements to real estate. If you owned the asset for a year or less before you sold it, your capital gain is short-term and you pay ordinary income tax rates. If you owned it more than a year, your capital gain is long-term and you will pay capital gains tax rates. Although as of 2012 the maximum rate is 15 percent, the rate was liable to increase in 2013.

    A capital loss is measured in the same basic way a capital gain is -- selling price minus adjusted basis. Nevertheless, you may not offset capital losses from the sale of assets such as your personal residence that you held for personal use rather than for investment purposes. Consequently, capital losses from the sale of personal assets will bring you no tax benefit.

    If you engaged in more than one capital asset transaction during the tax year, the IRS allows you offset your eligible short-term and long-term capital losses from your short-term and long-term capital gains to arrive at two figures – net short-term capital gain or loss and net long-term capital gain or loss. At that point you may offset your net losses against your net gains to arrive at your net capital gain or loss for the year. It is your net capital gain or loss for the year that determines your tax liability, not the result of any particular transaction. You report capital gains and losses on Form 1040, Schedule D and Form 8949.

    If you end up with a net capital loss for the year, you can subtract up to $3,000 of your excess loss from your other taxable income, or $1,500 if married filing separately. If your net capital loss exceeds $3,000, you can carry it over to the following tax year and subtract it from your income the same way – first to capital gains and next to a maximum of $3,000 in other income. If you still have excess capital losses, you can keep carrying them over to future tax years for as many years as you need to.

    You may not need to offset capital losses against capital gains that you enjoy as a result of selling your personal residence. If you make a profit from the sale of a home that you have owned and lived in for at least two of the past five years, you may exempt up to $250,000 from your calculation of capital gains. This exemption increases to $500,000 if you are married filing jointly. You can use this exclusion only if you haven’t used it for the sale of another home within the past two years.

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    About the Author

    David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.

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