Can Capital Losses Offset Ordinary Income? (2024)

Can Capital Losses Offset Ordinary Income? (1)

Capital losses can indeed offset ordinary income, providing a potential tax advantage for investors. The Internal Revenue Service (IRS) allows investors to use capital losses to offset up to $3,000 in ordinary income per year. But to understand this concept fully, it’s crucial to explore what capital losses are, the distinction between short-term and long-term losses, as well as the rules surrounding capital losses.

Need help managing your capital gains and losses? Speak with a financial advisor today.

What Is a Capital Loss?

A capital loss occurs when you sell an investment like a stock, bond or real estate property for less than its cost basis, which is often the original purchase price. Capital losses are the opposite of capital gains, which happen when you sell an investment for a profit. These losses are typically incurred in the financial markets due to fluctuations in asset prices.

Capital losses can be categorized as short-term or long-term, depending on how long you held the asset before selling it. Short-term capital losses result from assets held for one year or less, while long-term capital losses stem from assets held for over one year.

Short-term losses initially can offset short-term gains – the profits made from selling assets held for one year or less. Conversely, long-term losses can first offset long-term gains. Then, net long and short gains or losses are netted against each other. However, you should take note that the tax treatment of short- and long-term losses may differ.

How Capital Losses Can Offset Ordinary Income

Can Capital Losses Offset Ordinary Income? (2)

The IRS allows you to use capital losses to offset any capital gains you may have, which can reduce your overall tax liability. For example, say you made $8,000 in profits when you sold a stock that you held for over a year, but also took a $4,000 loss when you sold a different stock that you also owned for more than a year. The $4,000 capital loss would effectively reduce your $8,000 gain by half, leaving you to pay capital gains taxes on just a $4,000 gain.

What many taxpayers may not realize is that if your capital losses exceed your capital gains, you can use the remaining losses to offset ordinary income, such as your salary or business income. However, it’s essential to understand that there are limits to how much capital loss you can use to offset ordinary income.

For individuals, the maximum annual deduction for net capital losses against ordinary income is $3,000 ($1,500 if married and filing separately). If your losses exceed this limit, you can carry forward the remaining losses to future tax years, continuing to offset income until the losses are fully utilized.

For example, perhaps your total ordinary income for the year is $85,000, but you took a $5,000 capital loss on an investment that you sold and had no capital gains. The loss would lower your ordinary income for the year to $82,000 and leave you with $2,000 that you can deduct the following year.

How to Deduct Capital Losses

To deduct capital losses on your tax return, you must use Form 8949 and Schedule D. These forms help you report your capital gains and losses in detail. You’ll need to provide information about each investment sold, including the purchase and sale dates, the cost basis and the sale proceeds.

Form 8949 and Schedule D

Form 8949 is used to report the details of your capital asset transactions, both gains and losses. You’ll need to fill out this form for each transaction involving the sale of stocks, bonds, real estate or other investments. Each transaction’s information includes the date of sale, the description of the property, your purchase price and the sale price.

Part I of the form is where you’ll record your net short-term loss or gain, while Part II is used to record your net long-term loss or gain. You’ll then combine the two net totals to arrive at your total capital loss or gain.

After completing Form 8949, you’ll transfer the totals to Schedule D for IRS Form 1040, which provides an overview of your capital gains and losses. This form allows you to calculate the net capital gain or loss for the year. If your losses exceed your gains, you can use these losses to offset other income, potentially reducing your tax liability.

What Is the Wash Sale Rule?

Can Capital Losses Offset Ordinary Income? (3)

Keep in mind that there are rules surrounding reinvesting in assets that you previously sold at a loss and claimed a deduction. The wash sale rule is a regulation that prevents taxpayers from claiming a loss on the sale of a security if they repurchase the same security or a “substantially identical” one within 30 days before or after the sale.

Violating this rule could result in the disallowance of the loss deduction. Investors should be aware of the wash sale rule when managing their portfolios.

However, the wash sale rule doesn’t mean you lose the benefit of the loss forever. The disallowed loss is carried forward and added to the cost basis of the replacement investment. This can reduce your capital gains tax liability when you eventually sell the replacement investment at a gain.

Bottom Line

Capital losses can be a valuable tool for reducing your tax liability, not just because they can offset capital gains, but because they can be used to reduce ordinary income. The IRS allows you to use capital losses to offset capital gains, plus up to $3,000 of ordinary income in a given year. If your losses exceed this limit, the leftover losses can be carried forward and used in future years. Understanding the distinction between short-term and long-term losses, how to report them on your tax return, and the implications of the wash sale rule are all essential for optimizing your tax strategy.

Tax Planning Tips

  • If you want to get a headstart on filing your taxes this year, consider using SmartAsset’s tax return calculator first. The free tool can help you project how much you may owe or receive after filing your tax return.
  • Some financial advisors are also tax experts who can help you optimize your tax plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you canhave a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

Photo credit: © Onphalai, © smiles, © Seisa

Can Capital Losses Offset Ordinary Income? (2024)


Can you offset capital losses against ordinary income? ›

Capital losses can indeed offset ordinary income, providing a potential tax advantage for investors. The Internal Revenue Service (IRS) allows investors to use capital losses to offset up to $3,000 in ordinary income per year.

Can capital losses be offset against income? ›

Losses made from the sale of capital assets are not allowed to be offset against income, other than in very specific circ*mstances (broadly if you have disposed of qualifying trading company shares). You cannot claim a loss made on the disposal of an asset that is exempt from capital gains tax (CGT).

What is the maximum net capital loss that may be deducted against ordinary income? ›

Capital losses that exceed capital gains in a year may be used to offset capital gains or as a deduction against ordinary income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.

Can you write off 100% of stock losses? ›

If you own a stock where the company has declared bankruptcy and the stock has become worthless, you can generally deduct the full amount of your loss on that stock — up to annual IRS limits with the ability to carry excess losses forward to future years.

Can you carryover ordinary income with capital losses? ›

If you have more capital losses than gains, you may be able to use up to $3,000 a year to offset ordinary income on federal income taxes, and carry over the rest to future years.

Why are capital losses limited to $3,000? ›

The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.

How many years can you carry forward capital losses? ›

If the net amount of all your gains and losses is a loss, you can report the loss on your return. You can report current year net losses up to $3,000 — or $1,500 if married filing separately. Carry over net losses of more than $3,000 to next year's return. You can carry over capital losses indefinitely.

What is allowable capital loss? ›

Capital Gain or Loss. A capital gain or loss is generally the difference between the proceeds of sale, net of expenses, and the cost of the property. The taxable capital gain is 50% of the gain and the allowable capital loss is 50% of the loss. Allowable capital losses can only be deducted from taxable capital gains.

Can taxpayers completely offset with capital losses? ›

If you have capital losses in excess of what you can use this year to offset your capital gains and the $3,000 limit on offsetting ordinary income, you can carry forward your excess capital losses to future tax years until they are completely used.

Why is ordinary loss better than capital loss? ›

Ordinary loss, on the whole, offers greater tax savings than a long-term capital loss. An ordinary loss is mostly fully deductible in the year of the loss, whereas capital loss is not. An ordinary loss will offset ordinary income on a one-to-one basis.

Can I use more than $3000 capital loss carryover? ›

The $3,000 limit is the amount of capital loss carryover that can be used to offset ordinary income. There is no limit on how much of the carryover can be used to offset capital gains. For example, suppose you have a $20,000 capital loss carryover from 2021 to 2022.

What is the most capital loss deduction? ›

What happens if your losses exceed your gains? The IRS will let you deduct up to $3,000 of capital losses (or up to $1,500 if you and your spouse are filing separate tax returns). If you have any leftover losses, you can carry the amount forward and claim it on a future tax return.

Is it worth claiming stock losses on taxes? ›

Key Takeaways

Realized capital losses from stocks can be used to reduce your tax bill. You can use capital losses to offset capital gains during a tax year, allowing you to remove some income from your tax return.

What is the difference between ordinary loss and capital loss? ›

A capital loss results when you sell a capital asset, such as stocks and bond, for less than your cost. An ordinary loss occurs from the normal operations of a business when expenses exceed income. When capital losses exceed capital gains a net capital occurs.

How much stock loss can you write off in one year? ›

No capital gains? Your claimed capital losses will come off your taxable income, reducing your tax bill. Your maximum net capital loss in any tax year is $3,000. The IRS limits your net loss to $3,000 (for individuals and married filing jointly) or $1,500 (for married filing separately).

What type of income can capital losses offset? ›

A capital loss is a loss on the sale of a capital asset such as a stock, bond, mutual fund or real estate and can typically be used to offset other capital gains or other income.

Can you deduct capital losses with standard deduction? ›

You can. Capital losses are deductible on your tax return, and you can use them to reduce or eliminate capital gains or to reduce ordinary income up to certain limits. Here's how a capital loss can impact your taxes in the current year—and into the future.

How many years can you carryover capital losses? ›

You can carry over capital losses indefinitely. Figure your allowable capital loss on Schedule D and enter it on Form 1040, Line 13. If you have an unused prior-year loss, you can subtract it from this year's net capital gains.

Top Articles
Latest Posts
Article information

Author: Prof. An Powlowski

Last Updated:

Views: 6470

Rating: 4.3 / 5 (44 voted)

Reviews: 83% of readers found this page helpful

Author information

Name: Prof. An Powlowski

Birthday: 1992-09-29

Address: Apt. 994 8891 Orval Hill, Brittnyburgh, AZ 41023-0398

Phone: +26417467956738

Job: District Marketing Strategist

Hobby: Embroidery, Bodybuilding, Motor sports, Amateur radio, Wood carving, Whittling, Air sports

Introduction: My name is Prof. An Powlowski, I am a charming, helpful, attractive, good, graceful, thoughtful, vast person who loves writing and wants to share my knowledge and understanding with you.