The Internal Revenue Service treats all of the property you own as a capital asset, regardless of whether you hold it for investment or personal purposes. The capital asset tax rules allow you to reduce your capital gains with any type of capital loss. However, there are other favorable tax implications to your investment losses that aren't available for your personal property losses.
Investment Versus Personal
Before exploring the tax implications that result when you sell property at a loss, you must first become familiar with the characteristics that distinguish personal from investment property. Your investment properties include anything that generates income or that you hold for appreciation in value. Commonly, this includes stocks and bonds, as well as your real estate that generates rental income. Personal property, on the other hand, covers a wider range of assets since it includes virtually everything else you own. This includes your personal residences, household furnishings, boats, cars and jewelry. However, neither category ever includes the assets you use in a trade or business.
Netting Losses First
When you sell investment property at a loss, the IRS allows you to claim an annual deduction, but only on amounts that remain after netting the losses with your capital gains. The IRS requires you to net your gains and losses each year on a Schedule D attachment to your tax return. Initially, you must separately calculate your short-term capital gain or loss and your long-term gain or loss. You then net the two results together to arrive at your overall capital gain or loss. If a net gain results, meaning your gains exceed losses, you must pay the appropriate tax. However, if the net result is a loss, you can claim a tax deduction for amounts that relate to your investment property sales.
Deducting Investment Losses
Determining the amount of your net loss that is deductible requires you to identify the portion that relates to nondeductible personal property sales. For example, if you sell an investment property at a $5,000 loss, and in the same year you sell personal property at a $7,000 loss, your net loss for the year is $12,000. However, only the $5,000 investment loss is eligible for a deduction, and only for a maximum of $3,000 per tax year.
Future Loss Deductions
In the next tax year, you can continue to utilize the remaining capital loss balances, which after claiming the maximum $3,000 deduction in the prior year consists of a $2,000 investment loss and a $7,000 personal property loss. If you sell personal property at an $8,000 gain in the following year, the IRS requires that you first use your available loss balances to offset as much gain as possible before reporting a second investment loss deduction. Therefore, you offset the entire gain with $7,000 of the personal property loss and $1,000 of the investment loss. This allows you to claim a deduction for the remaining investment loss of $1,000 in the second year.
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