If you've taken a beating on an investment by selling a capital asset for less than its basis, which is typically what you paid for it, you have what's called a "capital loss." More specifically, a short-term capital loss is a loss you incurred after selling an asset less than a year after you bought it. But you can put this short-term loss to work for you as a tax write-off by using it to offset your ordinary income capital gains, within IRS annual limits.
Up to the annual limits, you can use short-term capital losses to offset ordinary income after canceling out your other capital gains.
Offset Gains with Short-Term Losses
The tax code allows you to use any amount of your short-term capital loss to offset capital gains for the year. First, you must offset any other short-term capital gains. If you still have short-term capital losses, you can then use the excess to offset long-term capital gains. Only after you’ve offset all of your other capital gains can you use any of your short-term capital losses to offset ordinary income.
For example, say you have a $10,000 short-term capital loss, a $6,000 short-term capital gain and a $5,000 long-term capital gain. You would first offset your entire $6,00 short-term gain, and then use the extra $4,000 of short-term capital losses to offset all but $1,000 of the long-term capital gain.
Capital Loss Offsetting Ordinary Income
Unlike the unlimited ability to offset capital gains, if your short-term capital loss exceeds all of your capital gains, you’re limited as to how much of your ordinary income you can offset, depending on your filing status. If your short-term capital losses exceed the limit for your filing status, you can carry forward the excess losses into future years when you can use them.
2019 Capital Loss Rules
The 2019 capital loss deductible amounts are the same as for 2018 -- no more than $3,000 against ordinary income (and no more than $1,500 for single filers and each spouse in the married filing separately tax status).
You report capital gains and deductible capital losses on Form 1040, Schedule D Capital Gains and Losses, and then transfer the information to line 11a of Form 1040.
2018 Capital Loss Rules
The Tax Cuts and Jobs Act, passed in December 2017, did not change the rules for writing off capital losses against ordinary income. In the 2018 tax year, if your capital losses exceed your capital gains, you’re limited to deducting no more than $3,000 against ordinary income, such as interest or wages. If you’re married but file separate returns, each spouse is limited to deducting no more than $1,500 of capital losses against ordinary income.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."