If you have gains or losses from your investments, those results are reported on Schedule D of your income tax return and the net results transferred to the Form 1040 tax return. The tax rules allow you to use investment losses to offset gains and reduce your total tax bill. Since they are taxed at different rates, gains and losses are divided into short- and long-term results.
If you sell an investment you will have either a capital gain or a capital loss. Investment gains are taxable and must be included on your annual tax return. Losses from investments can be used to offset or reduce gains and if you have more losses than gains for the year, you can use losses as a write-off against other income. The sale of an investment makes the gain or loss reportable. If you own investments and have not sold them you are not liable for any taxes.
Short or Long Term
The tax rules differentiate between short- and long-term capital gains and losses. If the investment was owned for one year or less, the result is classified as a short-term gain or loss. If the investment was owned for longer than a year you have a long-term gain or loss. Long-term gains are taxed at a lower rate than for other forms of income. Short-term gains are taxed at your regular income tax rate.
Schedule D Sections
All of your individual investment results are listed on IRS Form 8949, which has separate sections for short- and long-term investments. Depending on how your investment transactions are reported to the IRS, you may have to complete several forms 8949. The totals from the two parts of the 8949 are transferred to the Schedule D, which also has separate sections for short- and long-term results. Part II of the Schedule D will total your long-term gains and losses, producing a net gain or loss.
Using Long-term Losses
The steps of completing the Forms 8949 and Schedule D will result in your long-term losses being used to reduce any long-term gains from investments. If you have net long-term losses, those losses will be applied against any net short-term gains. Net short-term gains are transferred directly to the Form 1040. Net long-term gains require the completion of the Qualified Dividends and Capital Gain Tax Worksheet. If you have more losses than gains in total, the Schedule D will direct you to use up to $3,000 of the losses as a deduction on your tax return.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.