If you've had a rough year selling stocks, tax relief is in sight. Not only can you use your losses to offset any gains, you can also take a limited tax deduction. In addition, you can carry forward the excess loss into future years when, hopefully, you will have more gains to offset. However, you need to keep track of how much you have in short-term losses and long-term losses, because the difference can change how much tax you owe.
Identifying Short- and Long-Term Losses
Before you can calculate your short-term and long-term loss carry forwards, you have to distinguish between your short-term and long-term losses. A short-term loss is any loss on the sale of a stock you held for one year or less. A long-term loss is any loss on the sale of a stock you held for more than on year. When figuring your holding period, don't count the day you bought the stock but do count the day you sold it.
Calculate Losses Separately
Calculate your net long-term loss separately from your net short-term loss. If you carry forward a loss, it keeps its character so you can't simply lump all your losses together. For example, if you have short-term losses of $1,000 and $3,000 and long-term losses of $5,000 and $4,000, but also a long-term gain of $3,000, you have a net short-term loss of $4,000 and a net long-term loss of $6,000.
Figuring Your Deduction
If you have a net loss from your short-term and long-term trades, the IRS permits you to deduct up to $3,000 in that year, but you must carry forward the remainder. If you have both short-term and long-term losses, use up the short-term losses first in figuring your deduction. For example, if you have $4,000 in short-term losses and $6,000 in long-term losses, use $3,000 of your short-term losses for your deduction that year and carry over the remaining $1,000 of short-term losses and $6,000 of long-term losses to the following year.
Significance of the Difference
Short-term losses are more advantageous than long-term losses because short-term gains are taxed at the higher ordinary income tax rates. Long-term gains, on the other hand, are taxed at the lower capital gains rates. For example, assume you have $5,000 in short-term gains and $5,000 in long-term gains. If you have a $5,000 short-term loss carry forward, you wipe out your short-term gains and the $5,000 of long-term gains are taxed at the lower rate. However, if your $5,000 carry forward is a long-term loss, it wipes out the long-term gains leaving you with the $5,000 taxed at the higher ordinary income rates.
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