How Does Selling Stocks at a Loss Affect Taxes?

When an investment is sold for less than its purchase price, it results in a capital loss. The U.S. tax system permits investors to use these losses to lower their overall tax liability for the year. This process, often called tax-loss harvesting, allows a loss on an investment to become a tool for tax management.

The concept hinges on the idea of a “realized” loss. A stock that has decreased in value but is still held by the investor represents an unrealized loss and has no tax consequence. Only when the stock is actually sold does the loss become realized and reportable for tax purposes.

Calculating Your Capital Loss

To determine the amount of a capital loss, two figures are necessary: the cost basis and the sales proceeds. The cost basis is the total amount paid to acquire the stock, including the purchase price plus any associated costs like commissions. Sales proceeds are the total amount received from selling the stock, after subtracting any commissions paid on the sale. The calculation is: Sales Proceeds – Cost Basis = Capital Gain or Loss.

A negative result indicates a capital loss. The holding period of the stock determines if the loss is short-term (owned for one year or less) or long-term (owned for more than one year). For example, an investor buys 100 shares for $50 per share with a $10 commission, making the cost basis $5,010. If they sell all 100 shares ten months later for $40 per share and pay a $10 commission, the sales proceeds are $3,990, resulting in a short-term capital loss of $1,020. If the sale occurred after 13 months, it would be a long-term capital loss.

How Capital Losses Affect Your Taxes

The primary function of a capital loss is to offset capital gains. The IRS uses a specific order: short-term losses first offset short-term gains, and long-term losses offset long-term gains. After this, any remaining net losses can offset any remaining net gains in the other category. For instance, a net short-term loss of $2,000 can reduce a net long-term gain of $5,000.

If a net capital loss remains, taxpayers can use it to lower their ordinary income. The IRS limits this deduction to $3,000 per year ($1,500 for those who are married and filing separately).

Any net capital loss exceeding the $3,000 limit can be carried forward to subsequent tax years indefinitely. This carryover can be used to offset future capital gains or deduct up to another $3,000 from ordinary income.

The Wash-Sale Rule

The wash-sale rule prevents investors from claiming a tax loss while maintaining their position. A wash sale occurs if an investor sells a security at a loss and, within 61 days (30 days before or after the sale), they purchase a “substantially identical” security.

When a wash sale occurs, the loss is disallowed for the current tax year. Instead, the disallowed loss is added to the cost basis of the newly acquired shares, postponing the tax benefit until the replacement shares are sold.

The term “substantially identical” applies to a company’s stock and its options but generally not to the stock of a different company, even in the same industry. Careful tracking of purchase and sale dates is necessary to avoid triggering the rule.

Reporting Stock Losses on Your Tax Return

To claim a capital loss on a tax return, the transactions must be properly reported to the IRS. The process begins with information provided by a brokerage firm on Form 1099-B, “Proceeds from Broker and Barter Exchange Transactions.” This form details security sales for the year, listing proceeds, cost basis, and whether gains or losses are short-term or long-term.

The transactions from Form 1099-B are then reported on Form 8949, “Sales and Other Dispositions of Capital Assets.” This is where each sale is itemized. If a wash sale occurred, the taxpayer must enter code “W” in column (f) and adjust the gain or loss amount accordingly.

The totals from Form 8949 are summarized on Schedule D, “Capital Gains and Losses,” where the netting process takes place. The final capital gain or deductible loss amount from Schedule D is then transferred to the main Form 1040.