The property you own comprises your capital assets. Capital assets include personal property, such as your home or car, and investment property, such as stocks and bonds. If you sell a capital asset for less than its basis, which is what you paid for it, you'll have a capital loss. The IRS allows you to claim capital loss deductions to reduce your tax liability, regardless of whether the loss is short-term (property held for less than a year) or long-term (property held for more than a year).
Taxpayers can only claim capital loss deductions on sales of investment properties ... not on the sales of personal properties.
Long-Term vs. Short-Term Losses
The classification of a sale as representing a short-term or long-term capital loss depends on how long an investor held the asset in question. If the investor held the asset for one year or less, any capital gains or losses are classified as short-term. If the investor held the asset for more than one year, any capital gains or losses are defined as long-term.
The classification difference provides investors with an incentive to hold profitable investments longer because the tax rate for short-term capital gains is significantly higher than for long-term gains. For capital losses, however, the tax implications are the same, regardless of whether the investments are short-term or long-term.
Calculating a Loss
When determining the tax impact of capital gains and losses, all short-term gains are added together then reduced by the total of short-term losses. Likewise, all long-term gains are added together and reduced by the total of long-term losses. Then the short-term total and the long-term total are weighed against each other.
If investors have both short-term and long-term losses, they can add their losses to claim a deduction. If they have short-term and long-term gains, they pay the corresponding rates for each category. If they have losses in one category and gains in the other, this determines whether they claim a deduction or if they must pay taxes based on which one is larger. For example, a taxpayer with short-term gains that exceed his long-term losses must pay the short-term gains rate and cannot claim a deduction.
Claiming a Deduction
Taxpayers can claim federal income tax deductions on both short-term and long-term capital losses based on the rules for calculating a loss. In particular, taxpayers can claim a maximum deduction of $3,000 against other income, such as their salaries or interest they earned, during any tax year for short-term and long-term capital losses. The deduction is limited to $1,500 for each member of a married couple who is filing a tax return separately. The deduction should be figured on Schedule D of the federal tax return and reported on line 13 of Form 1040.
Deductions in Excess of $3,000
Although the IRS maintains limits for the deduction that a taxpayer can claim for a capital loss in any given year, the taxpayer can carry over any unused capital losses to subsequent tax years. The carryover total remains in its category so that a short-term loss would be added to short-term losses for the current tax year and would be used to reduce any existing short-term capital gains. Any remaining capital losses are carried over again to all subsequent years until they're completely spent.
Tom Gresham is a freelance writer and public relations specialist who has been writing professionally since 1999. His articles have appeared in "The Washington Post," "Virginia Magazine," "Vermont Magazine," "Adirondack Life" and the "Southern Arts Journal," among other publications. He graduated from the University of Virginia.