Not every investment goes the way you hoped, but you can take solace in the fact that the Internal Revenue Service lets you use your capital losses to offset your capital gains. In some cases, you can even use your losses to offset some of your ordinary income for the year.
Must Offset Capital Gains First
Before you can use the short-term capital losses to offset your ordinary gains, you have to first offset all of your capital gains, including long-term capital gains. For example, say you've lost $10,000 in total on your short-term transactions. If you've got $2,500 in long-term capital gains for the year, you have to offset that $2,500 first so you're left with a net capital loss of only $7,500.
Annual Deduction Limits
If you find yourself with more capital losses than gains for the year, you can use up to $3,000 of those losses each year as a write-off against ordinary income. If you're married filing separately, each spouse can claim up to $1,500.
If you've got more losses than you can deduct in a given year, the IRS lets you carry over the extra for as many years as you need until you've used them up. In addition, there's no limit on the amount of losses you can carry over. In future years, you can use the losses both for offsetting gains and for offsetting income up to the annual limit. For example, if you carry over $8,800 of short-term losses and $4,000 in capital gains in the next year, you would use the first $4,000 of the losses to offset the gains and the next $3,000 for the maximum loss. The remaining $1,800 is carried over to the next year.
Short-Term Losses Used First
If you have a net loss for both your long-term and short-term transactions, you have to use your short-term loss for the deduction first and carry over the long-term transactions. For example, if you're single and have $5,000 of short-term losses and $4,000 of long-term losses, when you take your $3,000 deduction, you have to use the short-term losses first. As a result, you'd use $3,000 of short-term losses for the deduction and carry over the remaining $2,000 of short-term losses plus the $4,000 long-term loss.
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