A long-term capital loss refers to money that you lose on investments held for more than 12 months. The alternative is a short-term capital loss, money lost on investments that you held for less than a year. When you do your taxes, each category of capital loss offsets its equivalent capital gains first. This can have very real consequences when it comes to determining your overall tax liability so it’s important to get right. You may want to consider working with a financial advisor who specializes in tax planning in order to help you make the best overall tax strategy.
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The IRS breaks investment income up into two categories: long-term and short-term. A long-term investment refers to any asset that you held for 12 months or more before selling it. A short-term investment refers to any asset that you held for less than 12 months before selling it. Note that both of these categories only refer to capital gains. Yields, like dividends and interest payments, have their own rules that don’t account for the length of ownership.
When you sell an asset, the result is known as either a capital gain or a capital loss. You collect a capital gain when selling the asset for more than its tax basis, the term for how much you originally paid. For example, if you buy a group of stock shares for $1,000, that purchase price is the stock’s tax basis. If you sell it for $1,500, then, you have a capital gain of $500. Capital gains are your profit on the transaction.
Capital losses work the other way around. If you sell an asset for less than its tax basis, you have taken a loss. For example, if you buy a group of stock shares for $1,000 and sell them for $800, you have a capital loss of $200. You can take a capital loss despite collecting money on the sale because you made less money than you spent.
This creates four basic categories of capital transactions:
In general, there are three important elements to understanding long- vs. short-term capital losses. Each has its own benefits that you may want to consider before making your own tax strategy.
First, long-term and short-term capital gains are taxed at different rates. When you sell your investments, any short-term capital gains are taxed at the rate of ordinary income. You end up including those sales alongside salary, wages, contract work and all other forms of taxable income.
Long-term capital gains are taxed at a separate capital gains rate. For investors, it’s almost always better to try and hold assets longer because capital gains tax rates are significantly lower than the rates that you pay on earned income.
You also only pay taxes on your net gains. This means that every year, you calculate your taxes by adding up all of your capital gains for the year, then deducting all of your capital losses. The result is the final amount on which you owe taxes.
For example, say that you had four stock sales over the year:
Your total gains for the year would be $750 (the $500 sale + the $250 sale). Your total losses for the year would be $400 (the $100 loss + the $300 loss). This would leave you with a net gain of $350 (the $750 total gain – the $400 total loss). You would pay taxes on the $350 net gain.
Losses deduct from their same category of gains before applying to any other income. This means that when you calculate your investment taxes each year, you follow three basic steps:
First, calculate your same-category net gains. You add up your total long-term capital gains and deduct your total long-term capital losses. You also add up your total short-term capital gains and deduct your total short-term capital losses.
Second, apply any excess losses across categories. If your long-term capital losses exceed your long-term capital gains, you apply the excess to any remaining short-term capital gains. If your short-term capital losses exceed your short-term capital gains, you apply the excess to any remaining long-term capital gains.
Third, if you have more overall losses than gains, you can roll the remaining losses over.
If your total capital losses exceed your gains you are eligible for two more deductions. First, you can deduct up to $3,000 in excess capital losses from your ordinary income each year.
If your combined capital losses exceed both your combined capital gains and the $3,000 deduction cap, you can then roll those losses forward. This means that in future tax years, you can deduct your remaining losses from previous tax years.
For example, say you had net capital gains of $5,000 in this tax year and excess losses of $1,000 last year. You can roll those losses forward and apply them to this year, leaving you with a net taxable capital gain of $4,000 (the $5,000 gain this year – the $1,000 total excess losses last year).
Excess losses are not unique to long-term capital losses. They are the result of your combined long- and short-term losses. However, they’re an important part of the overall system of deductions.
Long-term capital losses are any losses you take when selling an asset that you have held for 12 months or more. They can offset any long-term capital gains, serving as an effective deduction that reduces your tax bill overall. You may want to consider working with a professional to fully understand how these losses could impact your personal tax situation.
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Eric ReedEric Reed is a freelance journalist who specializes in economics, policy and global issues, with substantial coverage of finance and personal finance. He has contributed to outlets including The Street, CNBC, Glassdoor and Consumer Reports. Eric’s work focuses on the human impact of abstract issues, emphasizing analytical journalism that helps readers more fully understand their world and their money. He has reported from more than a dozen countries, with datelines that include Sao Paolo, Brazil; Phnom Penh, Cambodia; and Athens, Greece. A former attorney, before becoming a journalist Eric worked in securities litigation and white collar criminal defense with a pro bono specialty in human trafficking issues. He graduated from the University of Michigan Law School and can be found any given Saturday in the fall cheering on his Wolverines.
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