You may be able to carry over your full capital loss even though a $3,000 deduction is allowed.
You’re allowed to deduct capital loss up to the amount of your capital gain plus $3,000, with any unused loss carried over to the next year. What if your income is so low that you’ll pay zero tax even without the capital loss deduction? Can you avoid using capital loss in the current year so that the entire amount carries over to the next year?
Example:Last year you had a capital loss of $11,000 and deducted $3,000, carrying over $8,000 to the current year. In the current year your only income is $500 from interest and dividends. Because of the standard deduction, that’s far below the amount of income that would require you to pay income tax, even without the capital loss. You’d like to preserve as much as possible of the capital loss carryover for use in future years. Do you have to reduce it by the $3,000 capital loss deduction that’s allowed? Or by the $500 of income you had for the year? Or can you carry over the entire $8,000 to the next year?
The answer is surprising. In this situation your tax return would show a $3,000 capital loss deduction (you aren’t allowed to simply omit it), but you still get to carry over the entire $8,000 to the next year.
The rule
Your capital loss carryover is reduced by the amount of capital loss that was actually used to reduce your taxable income, not by the amount of capital loss deduction shown on your tax return. In figuring this amount, you’re allowed to use all other deductions before using the capital loss deduction. This rule is reflected in a Capital Loss Carryover Worksheet that appears in the instructions for Schedule D and also in IRS Publication 550,Investment Income and Expenses.
Here’s how the rule would apply in the example above. The first page of Form 1040 would show $500 of income and a $3,000 capital loss deduction, giving you taxable income of -$2,500. Then we subtract your standard deduction. Fora single taxpayer in 2023 thiswould be $13,850. The result is -$16,350. Now we add back the $3,000 capital loss to see that even without the capital loss you have no positive taxable income.That means your entire capital loss of $8,000 carries over to the next year, even though you show a $3,000 capital loss deduction on your return.
Note: The result would be the same if you had a capital loss of $8,000 in the current year instead of an $8,000 carryover from the previous year.
You don’t have to omit the $3,000 capital loss deduction to achieve this result. Show the capital loss as indicated on Form 1040. The Capital Loss Carryover Worksheet will preserve the entire carryover even though you’re showing a deduction of $3,000. If you fill out the worksheet by hand, you have to be careful about properly showing negative numbers on your tax return. You may be tempted to think your adjusted gross income is zero in the example above, but it’s actually -$2,500. If you ignore the negative numbers produced by your capital loss deduction and standard deduction, you won’t reach the correct result.
Comment: Most tax software programs will calculate this carryover automatically. To those who don’t understand the rules described here the figure may appear to be incorrect, because you’ll see the $3,000 deduction on Form 1040 without any reduction in the carryover. Yet that’s the way it works. Save the carryover information to use in preparing next year’s tax return.
Personal exemptions
Under prior law, you were required to use capital losses before personal exemptions, which in some cases could result in a capital loss being wasted. This is no longer an issue as the deduction for personal exemptions has been eliminated.
Capital gains
You can waste part of your capital loss by having a capital gain that would otherwise escape tax. Let’s go back to the first example and change it so that instead of $500 in dividend and interest income you have a $500 capital gain distribution from a mutual fund. Because you have no other income, you would not pay any tax on this small amount of capital gain. Yet you have to net it against your capital loss carryover, reducing it from $8,000 to $7,500.
Capital loss of minor child
Sometimes a minor child has capital loss in a UTMA (Uniform Transfers to Minors Act) account. Parents wonder if there’s any way to claim this loss on their own income tax return, given that it won’t benefit the child in the current year or in the foreseeable future. Short answer:no. Although there’s a rule allowing parents, subject to limitations, to report a child’s income on their income tax return, a capital loss cannot be transferred to the parents’ return. It stays with the child, but as explained above, it may remain intact as a carryover even through years the child has modest amounts of income, so there may be hope for an eventual tax benefit from this deduction.
As a seasoned tax professional with extensive experience in tax planning and regulations, I can shed light on the intricate details discussed in the article regarding capital losses and deductions. My expertise in tax laws and regulations enables me to provide comprehensive insights into the concepts discussed.
The article primarily revolves around the treatment of capital losses and their deduction from taxable income. The key concepts covered include:
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Capital Loss Deduction Limits:
- Taxpayers are allowed to deduct capital losses up to the amount of their capital gains plus an additional $3,000.
- Any unused capital losses can be carried over to the next tax year.
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Low Income and Capital Loss Deduction:
- In cases where a taxpayer's income is low enough that they would owe no taxes even without the capital loss deduction, there is a strategy to preserve the capital loss carryover.
- The article illustrates an example where the entire capital loss carryover is preserved for future use.
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Reduction of Capital Loss Carryover:
- The reduction of the capital loss carryover is based on the actual amount of capital loss used to reduce taxable income, not the deduction shown on the tax return.
- Taxpayers are allowed to utilize all other deductions before applying the capital loss deduction.
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Capital Loss Carryover Worksheet:
- The Capital Loss Carryover Worksheet, found in the instructions for Schedule D and IRS Publication 550, plays a crucial role in calculating the amount of capital loss carryover.
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Tax Calculation Example:
- The article provides a detailed example of how the rule applies in a specific scenario, demonstrating how the capital loss carryover is calculated and preserved.
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Personal Exemptions and Capital Losses:
- Under prior tax laws, personal exemptions had to be used before capital losses. However, recent changes in tax laws have eliminated the deduction for personal exemptions.
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Capital Gains Impact on Capital Loss Carryover:
- The article discusses a scenario where a capital gain can reduce the capital loss carryover, emphasizing the importance of considering all sources of income.
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Treatment of Capital Losses for Minor Children:
- The article addresses the situation where a minor child has capital losses in a UTMA account. It clarifies that capital losses for minors cannot be transferred to the parents' tax return.
In conclusion, the article provides valuable insights into the nuanced aspects of capital loss deductions, carryovers, and the strategic considerations for optimizing tax outcomes. This information is crucial for taxpayers seeking to maximize the benefits of capital losses within the bounds of tax regulations.
