The only way to report a capital loss on your income tax return is by selling your property for an amount that is less than you purchased it for. And although you can use all capital losses to reduce your capital gains, the IRS limits the amount you can deduct in years your losses exceed your gains.
Capital Asset Rules
Every piece of property you own, whether it's real estate, personal items, or even an intangible asset such as a patent, is subject to the capital asset tax rules. When you sell capital assets, the IRS imposes tax rules that differ from those that apply to your ordinary income, such as your employment wages. Moreover, lower rates of tax apply to your long-term gains, which result from the sale of assets you own for more than one year. The IRS considers gains from assets you hold for one year or less to be short-term gains. There are never any tax consequences at the time you purchase or construct a capital asset; rather, you report your taxable gains and losses when you sell it.
Calculating Tax Basis
The term tax basis refers to a taxpayer's total investment in a property. For an asset that you purchase, your tax basis is the purchase price. But if you construct an asset, such as building a home on vacant land, your tax basis includes all of the costs you incur to build the home, which includes materials, supplies, labor and even the cost of obtaining permits. Regardless of whether you construct or purchase the asset, you can increase the tax basis for the expense of making permanent improvements to it. The reason you need to keep track of tax basis is because it determines whether you will report a gain or loss when you eventually sell it.
Personal Property Losses
Federal tax law distinguishes between capital assets you own for personal and investment purposes. When the sale of your asset results in a gain, the distinction is not important since gains resulting from the sale of both categories of assets are subject to the capital gains tax. However, when you sell an asset at a loss, only the losses that relate to your investment property are eligible for a maximum $3,000 deduction. Although there is no deduction for your personal losses, you can use them in future tax years to offset capital gains.
Personal Capital Assets
When reporting capital transactions on a Schedule D attachment to your income tax return, it's important that you identify which losses relate to investments, and those that relate to personal property. Personal property is anything you use for your own use. Common examples include your automobile, the home you live in, boats and even the furnishings in your house. In contrast, investment property commonly refers to the financial investments you hold, such as stocks and bonds, as well as real estate that you rent to tenants or hold solely as an investment.
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