The capital loss definition is the sale of a capital asset – almost anything you own or use for personal or investment use like a house, car, or stocks – for less than your basis, which is generally what you paid for the asset. Generally, losses on personal assets, such as your home or car, aren’t deductible, but investment losses can reduce your tax bill. Capital losses are divided into two categories: short-term capital losses, which are losses on assets you owned for a year or less, and long-term capital losses, which are losses on assets you owned for more than one year.
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.
Understand 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.
You report capital gains and deductible capital losses on Form 1040, Schedule D Capital Gains and Losses, and then transfer the information to line 13 of Form 1040.
2017 Deduction Limits the Same
The limits for deducting capital losses against your ordinary income on your 2017 tax return are the same as the 2018 limits: $3,000 if your filing status is anything other than married filing separately and $1,500 if you’re married filing separately. If your capital losses exceed the limits, you can carry forward the nondeductible portion and use it in the following tax year.
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