What Is the Maximum Capital Loss Deduction?

When you sell a capital asset, such as stocks or bonds, for less than its purchase price, you incur a capital loss. This loss can provide a tax benefit by reducing your taxable income. The Internal Revenue Service (IRS) has specific rules that govern how much of this loss can be deducted in a single tax year.

The Annual Deduction Limit

The tax code sets a boundary on how much capital loss can be used to offset your ordinary income each year. The maximum capital loss deduction against income like wages or interest is $3,000 per year. This amount is halved to $1,500 for those who are married but file separate tax returns. This deduction limit applies only after you have first used your capital losses to offset any capital gains from the year, as there is no limit on using losses to offset gains.

For instance, if you have $10,000 in capital gains and $15,000 in capital losses, you first use $10,000 of your losses to cancel out the gains. This leaves you with a net capital loss of $5,000. From this remaining loss, you are permitted to deduct $3,000 from your other sources of income, such as your salary.

Calculating Your Net Capital Loss

Before applying the annual deduction limit, you must calculate your net capital loss. This process involves netting your gains and losses based on how long you held the assets. The holding period determines if a gain or loss is short-term (held one year or less) or long-term (held more than one year).

The calculation requires netting all short-term gains against short-term losses, and then doing the same for long-term assets. Once you have these two net figures, you net them against each other. For example, a net short-term loss of $2,000 and a net long-term gain of $1,000 results in an overall net capital loss of $1,000. These transactions are reported on Form 8949 before being summarized on Schedule D.

Handling Losses Exceeding the Limit

If your net capital loss for the year is greater than the annual deduction limit, the excess amount is not lost. The tax code allows you to carry this excess loss forward to subsequent tax years. This is known as a capital loss carryover, which you can carry forward indefinitely until fully used.

A carryover loss maintains its original character as either short-term or long-term. When you carry a loss into the next tax year, it is combined with the gains and losses you incur in that new year. For example, a long-term capital loss carryover will first be used to offset any long-term capital gains in the new year.

The $3,000 annual deduction limit also applies to carryover losses used to offset ordinary income. You can determine the amount of your carryover by using the Capital Loss Carryover Worksheet, found in the instructions for Schedule D or in IRS Publication 550. Reviewing your prior year’s Schedule D is the first step to identify a carryover.

Important Limitations on Capital Losses

Certain rules can prevent you from claiming a capital loss. These limitations are designed to prevent taxpayers from creating artificial losses for tax purposes.

The Wash Sale Rule

The wash sale rule disallows a loss deduction if you sell a security at a loss and purchase a “substantially identical” security within a 61-day period. This window includes the 30 days before the sale, the day of the sale, and the 30 days after. The rule applies to stocks, bonds, mutual funds, and ETFs.

If a loss is disallowed by the wash sale rule, it is not permanently lost. The disallowed amount is added to the cost basis of the new, substantially identical security you purchased. This adjustment postpones the tax benefit of the loss until you sell the replacement security. The holding period of the original stock is also added to the holding period of the new stock.

Losses on Personal-Use Property

Losses from the sale of assets you own for personal use, such as your primary residence, car, or household furniture, are not deductible. These are considered personal expenses. In contrast, any gains you might realize from selling such property are generally taxable unless a specific exclusion applies, like the home sale exclusion.

Related Party Transactions

The tax code also disallows losses on sales of property to related parties. A related party includes immediate family members like spouses, children, parents, and siblings. It also extends to entities that you control, such as a corporation or partnership where you own more than 50% of the interest. These rules, found in Section 267 of the Internal Revenue Code, prevent generating tax losses without a true economic change in ownership.