Rules About Stock Losses for Federal Taxes

by David Carnes

Corporate stock is considered a capital asset by the Internal Revenue Service because people it for investment purposes. When you sell a share of stock for less than what you paid for it, you incur a capital loss. Capital losses trigger favorable federal income tax consequences that you may take advantage of when you prepare your tax return.

Realized Losses

To claim a capital loss, the loss must be realized. This simply means that you may not write off a "paper loss": You incur a realized capital loss only if sell the stock at a loss.

Short-Term vs. Long-Term

You incur a short-term capital loss when you lose money on the sale of shares that you have held for one year or less. You incur a long-term capital loss if you lose money on the sale of shares you have held for longer than a year. If you have short-term capital losses, you must deduct them from any short-term capital gains you have incurred (not necessarily related to the sale of stock) before you may deduct any short-term capital losses from your ordinary income. Likewise, you must deduct long-term capital losses from long-term capital gains you have incurred before you may deduct long-term capital losses from your ordinary income. This is significant because the IRS taxes short-term capital gains at ordinary income tax rates, while it taxes long-term capital gains at special (usually lower) rates. This means that writing off short-term capital losses will probably save you more money than writing off long-term capital losses.

Deducting Excess Losses

If the total of your short-term and long-term capital losses exceeds the total of your short-term and long-term capital gains, you may deduct the amount by which your losses exceed your gains (your net capital loss) from your ordinary income, up to an annual deduction limit of $3,000. If you reach this deduction limit and still have undeducted capital losses, you may carry them forward to the following tax year.

Filing Requirements

You must report your capital losses on Schedule D. You must report each type of share you sold, when you bought it, how much you paid for it, when you sold it and the price for which you sold it. Schedule D requires you to separately calculate short-term and long-term capital losses. You must report your net capital gain or loss (capital gains minus capital losses) on Line 13 of Form 1040.

About the Author

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.

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