Tax Benefits of Losses

by David Carnes

    You can gain from your losses, at least with the IRS. Normally, you won't be able to save more money in taxes than the amount you lost, but you will be able to mitigate your losses with a lower tax bill. Several different types of losses can be deducted from your federal taxable income.

    Capital Losses

    Most of your property is probably classified as a capital asset by the IRS, although certain assets, such as inventory, are not. You incur a capital loss when you sell a capital asset you held for investment purposes at a loss. If your total capital losses during the tax year exceed your total capital gains, you can take a capital loss deduction of up to $3,000, and carry any excess losses forward to subsequent tax years. You generally can't deduct losses from the sale of items you hold for personal use rather than investment purposes, such as your personal automobile.

    Casualty and Theft Losses

    Casualty losses are sudden losses due to an unforeseen natural disaster, such as a storm, earthquake or tornado. To claim a casualty or theft loss, you must file a timely insurance claim if the property was covered by insurance. Generally, you should calculate your loss in terms of diminution in the fair market value of the property. If your insurance company reimburses you, you must reduce your deduction by the amount of your reimbursement. If loss occurred to personal property, you must subtract another $100 per incident of casualty or theft. Finally, you must reduce your total deduction by 10 percent of your adjusted gross income.

    Net Operating Losses

    If you are self-employed and you incur a net operating loss for the tax year -- in other words, if your business expenses exceed your business income-- you can deduct the loss from your taxable income. Generally, you can deduct a net operating loss only if your tax deductions would exceed your taxable income even without claiming the loss. Fortunately, you can carry forward the excess loss to future tax years. You may even be able to carry back your losses to previous tax years, file amended tax returns and claim a tax refund. You can take this deduction as a sole proprietor, but not as a partner or a member of a limited liability company.

    Bankruptcy Losses

    Debt cancellation carries tax consequences. If you negotiate a private settlement with your creditors that allows you to pay less than you owe, the IRS normally treats the difference between what you paid and what you owed as income for tax purposes. If your debts were cancelled due to bankruptcy, however, the IRS will not treat cancelled debt as income. This loophole can help compensate you for losses you incur when, for example, your property is liquidated in a Chapter 7 bankruptcy proceeding.

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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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