Capital gains are made on the purchase of certain assets, such as securities, that appreciate in value and are sold for a profit at a later date. Similarly, capital losses are incurred from selling property purchased on one date at a later date for less money than it was originally purchased for. The IRS allows individuals to deduct a certain number of capital losses from their taxes.
A capital loss from the stock market is incurred when you purchase a stock at one price and then sell it again at a lower price. For example, if a person buys 100 shares at $50 each and then, later, sells them all for $25 each, he would experience a capital loss of $25 per share, or $2500 total. Brokers fees and commissions do not count as part of a capital loss, as this constitutes payment for a service.
Offsetting Capital Gains
When a person experiences capital gains, he must pay taxes on the profit he reaps. As of the time of publication, the capital gains tax is set at 15 percent. If you bought 100 shares of stock at $50 and then the stock moves up to $150, you would experience a net profit of $100 per share, or $10,000. Under normal capital gains tax rates, you would have to pay a tax of $1500 on this money. However, you can use capital losses to offset capital gains. So, if you had $9000 of capital losses in the same year, you would only be taxed on $1000 of profits, or $150.
Deductions from Income
In addition, the IRS allows an individual to deduct up to $3000 annually from his tax burden in the form of capital loss deductions. This means that an individual with $20,000 worth of taxable income who has $3000 in capital losses can deduct this money from his taxable income and pay taxes on only $20,000. If the capital losses exceed $3,000, the additional losses can be carried over to the next year and deducted then.
There is a separate rule, known colloquially as the wash rule, that prevents people from claiming capital losses just for the purposes of reducing their tax burden. This rules states that a person cannot claim a credit on a security that they repurchase within a month of the time that they sold the same security for a loss.