How to Deduct Stock Losses on Your Taxes
Navigate the tax rules for investment losses. This guide details the steps for calculating and applying stock losses to help manage your overall tax outcome.
When you sell a stock for less than you paid, the resulting loss can be used to your advantage when filing taxes. Understanding how to account for these losses is part of effective tax planning. The Internal Revenue Service (IRS) has specific rules that govern how investors must calculate, apply, and report stock losses, which can lower their overall tax liability.
Determining Your Capital Loss
A stock loss is only relevant for tax purposes when it is “realized” by selling the stock. An unrealized loss on a stock you still own has no immediate tax consequence. Your loss is determined by subtracting the amount you received from the sale from your “cost basis.”
Your cost basis is the original price you paid for the stock, including any commissions or fees associated with the purchase. For example, if you purchased 100 shares of a company at $50 per share and paid a $10 commission, your cost basis is $5,010. If you later sell all 100 shares for $4,000, your realized loss is $1,010.
The timing of your ownership is a factor in how the loss is categorized. A short-term capital loss results from selling a stock held for one year or less. A long-term capital loss occurs when you sell a stock owned for more than one year. This distinction is important because the two types of losses are treated differently on your tax return.
Applying Losses to Offset Gains
The primary way stock losses provide a tax benefit is by offsetting capital gains through a process called “netting.” You must first use losses to offset gains of the same type. This means short-term losses are subtracted from short-term gains, and long-term losses are subtracted from long-term gains.
Imagine you have a $5,000 short-term gain and an $8,000 long-term gain. You also have a $6,000 short-term loss and a $3,000 long-term loss. First, you net the short-term amounts, resulting in a $1,000 net short-term loss. Next, you net the long-term amounts, leaving a $5,000 net long-term gain.
After this initial step, if a net loss remains in one category and a net gain in the other, you can use the loss to offset the remaining gain. In the example above, the $1,000 net short-term loss would be used to offset the $5,000 net long-term gain. This leaves you with a final net long-term capital gain of $4,000, which is the amount you would be taxed on.
The Capital Loss Deduction Limit
If your total capital losses exceed your total capital gains after netting, you have a net capital loss. The IRS allows you to deduct a portion of this loss against other income, such as your salary. The annual limit on this deduction is $3,000 per year for individuals and those married filing jointly, and $1,500 for those married filing separately.
If your net capital loss for the year is greater than the annual limit, you cannot deduct the entire amount in one year. For instance, if you have a net capital loss of $10,000, you would deduct $3,000 from your ordinary income. The remaining $7,000 becomes a “capital loss carryover.”
This carryover amount can be used in future tax years. In the following year, the carryover loss would be applied against any capital gains you realize. If you still have a net loss after offsetting gains, you can again deduct up to $3,000 against ordinary income. This process continues until the entire loss has been used.
Special Rules and Considerations
The “wash-sale rule” can affect your ability to claim a stock loss. This rule prevents you from claiming a loss on a stock sale if you purchase a “substantially identical” security within 30 days before or 30 days after the sale. This 61-day window is designed to stop investors from realizing a tax loss only to immediately buy back the stock.
If you violate the wash-sale rule, the loss is disallowed for the current tax year. The disallowed loss is not permanently forfeited; instead, the amount is added to the cost basis of the new shares you purchased. This adjustment defers the tax benefit until you sell the new shares.
Another situation involves securities that become completely worthless. If a stock you own becomes worthless, you can treat it as a capital loss. The IRS considers a worthless security to have been sold for $0 on the last day of the tax year in which it became worthless. This timing determines whether the loss is classified as short-term or long-term.
Reporting Losses on Your Tax Return
To deduct your stock losses, you must report them to the IRS on specific forms, beginning with Form 8949, “Sales and Other Dispositions of Capital Assets.” On this form, you will list the details of each stock sale, including purchase date, sale date, cost basis, and sale proceeds. The form requires you to separate your sales into short-term and long-term transactions.
After completing Form 8949, you transfer the summary totals to Schedule D, “Capital Gains and Losses.” On Schedule D, you will combine your short-term and long-term totals to determine your final net gain or loss for the year.
If you have a net capital loss, Schedule D guides you in calculating the deductible amount and any capital loss carryover. This final deduction is then transferred from Schedule D to your main tax return, Form 1040, where it reduces your adjusted gross income.