When you lose money in the stock market, you are not taxed on your loss. In fact, subject to certain restrictions, you may claim capital losses and write off these losses against your taxable income. To write off capital losses, however, they must have been realized, meaning you must have actually sold the stocks at a loss, rather than simply incurred losses on paper. Short-term and long-term capital losses are subject to similar tax treatment.
Classifying Your Losses
The IRS classifies capital losses and gains as either short-term or long-term. A short-term loss occurs when you hold the stock for one year or less before selling it, and a long-term loss occurs when you hold the stock for longer than a year before selling it. Short-term capital losses must be calculated separately from long-term capital losses for tax purposes.
Deducting Your Losses
When deducting your losses, you must first deduct short-term losses from short-term gains. The short-term capital gains you deduct them from need not be stock market gains -- they can be gains realized from the sale of an asset held strictly for investment purposes, such as real estate. Short-term losses are more useful than long-term losses because they reduce the amount of your taxable short-term capital gains, which are taxed at ordinary income tax rates. Long-term capital losses reduce the amount of your taxable long-term capital gains, which are taxed at capital gains tax rates (usually 15 percent or less).
If your net capital losses (short-term plus long-term) exceed your net capital gains, you may deduct up to $3,000 of the excess from your ordinary taxable income. If this deduction is still not enough to exhaust your capital losses, you may carry over the remainder to the following tax year and treat them as if they were realized that year.
Keep all records pertaining to your capital losses for two or three years in case of an IRS audit. You must report your short-term capital losses on Line 13 of Form 1040, and calculate your adjusted gross income accordingly. You must also complete the version of Schedule D that is designed to be used with Form 1040.
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