If you lose money on the stock market, you may be able to deduct the value of your losses from your taxable income on Form 1040. To deduct a loss, you must have actually incurred it -- losses that appear only on paper due to fluctuating stock prices do not entitle you to a deduction.
For tax purposes, the amount of your capital loss for a particular stock transaction is equal to your shares' adjusted basis minus the price you sold them for. The basis of your shares equals the amount you paid for them plus any associated fees, such as brokerage fees. The basis may be adjusted under certain circumstances, however. If there was a stock split after you purchased your shares, for example, you must adjust your shares' basis to reflect the magnitude of the split -- a 2-for-1 stock split, for example, would require you to reduce each share's basis by 50 percent.
Short-Term Losses vs. Long-Term Losses
If you sold your stocks after holding them for no more than a year, your capital loss was short-term. If you sold them after holding them for more than a year, your loss was long-term. This distinction is important not only in calculating your deduction, but also in determining your taxable capital gains from other transactions you may have engaged in. Since you can use short-term capital losses to offset short-term capital gains, and since short-term capital gains are taxed at a higher rate than long-term capital gains, short-term capital losses can be particularly useful in reducing your tax bill.
Calculating Your Loss
To calculate your deductible capital loss, add together all of your capital losses during the tax year from any transaction involving investment property, whether or not stock-related -- losses from the sale of rental property, for example. You must also add together all of your capital gains. Next, you must classify your gains and losses into net short-term and net long-term gains or losses. Finally, offset your net short-term gain or loss against your net long-term gain or loss. If the final result is negative, you have incurred a net capital loss for the year. If it is zero or positive, you have no capital loss to write off.
Claiming the Deduction
You can deduct a net capital loss of up to $3,000 for the tax year in which you incurred it ($1,500 if you are married and filing separately). If your loss was greater than $3,000, you can carry the excess forward to future tax years for an unlimited number of tax years. Report your capital losses on Form 8949 and Form 1040. If your only capital gain or loss is a capital loss carried forward from a previous tax year, you may not even have to file Form 8949.
- Internal Revenue Service: Ten Important Facts About Capital Gains and Losses
- Internal Revenue Service: Topic 409 - Capital Gains and Losses
- Bankrate.com: Capital Losses Can Cut Taxes
- Internal Revenue Service: RS Reminds Taxpayers They Can Use Stock Losses to Reduce Taxes
- Internal Revenue Service: Sales and Trades of Investment Property
- Internal Revenue Service: Eight Facts about New IRS Form 8949 and Schedule D
David Carnes has been a full-time writer since 1998 and has published two full-length novels. He spends much of his time in various Asian countries and is fluent in Mandarin Chinese. He earned a Juris Doctorate from the University of Kentucky College of Law.