Are Losses in Mutual Funds Tax-Deductible?
If you have a mutual fund account that has decreased in value, you can use the loss as a tax deduction, but only if you have sold your fund shares. A loss on a mutual fund investment is included in the capital gains and losses reporting on your income tax return.
Realized Vs. Unrealized Loss
To claim a loss from your mutual fund investment, you must have "realized" the loss -- that is, you must have sold some or all of the shares before the end of the year. If you have not sold any of your fund shares, your loss is "unrealized," meaning that the loss is not fixed or final -- as long as you still own the shares, their value could go up next week, next month or next year. You don't make the loss "real" until you sell the shares and receive a lower price than you paid. You may only take a tax deduction on realized losses.
Claiming the Loss
After selling your mutual fund shares, the amount you received from the sale will be easy to determine. Your loss will be the difference between the sale process and your cost basis. You cost basis includes all of the money you paid to buy shares plus the value of any dividends and capital gains paid by the fund and reinvested into more shares for your account. The necessary numbers will be provided to you by your mutual fund company on Form 1099-B. The figures from the 1099 are transferred to an IRS Form 8949, and results from that form go on the Schedule D, Capital Gains and Losses.
Using Capital Losses
The tax rules are very specific on how an investment loss -- called a capital loss -- must be used when you file your taxes. All gains and losses are classified as short-term or long-term: short-term means that you held the asset for one year or less; long-term means you help the asset longer. Capital losses must first be used to reduce capital gains of the same type. For example, short-term capital losses must be applied against short-term capital gains. Then any remaining losses are used to offset the other type of gains -- you could apply excess short-term losses against long-term gains, for example. Finally, any capital losses in excess of your total capital gains can be used to reduce your other income up to a maximum of $3,000 in any year. Excess losses can be carried forward to future tax years.
Avoid a Wash Sale
The tax rules will disallow your loss write-off if you sell your mutual fund shares and buy them right back. This tactic is referred to as a "wash sale." The wash sale rule requires that you have not purchased replacement shares in the same mutual fund within 30 days before or after you sold your shares for a loss. If you want to use your mutual fund losses as a tax write-off -- but want to stay invested in the fund -- sell your shares and wait at least 31 days before again buying into the fund.
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Writer Bio
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.