Most of us are aware that you have to net out your capital gains and losses when figuring your taxes for the year. But how does all this netting work? Should I be hanging around the local dock to learn how to net my capital gains and losses? Let's try to unravel some of this mystery.
First, there are a couple of levels of netting. Long-term items are netted separately from short-term items. Then, the long and short are netted together to produce the final result. It's easiest to just look at an example.
Suppose that Long John Silver sold two stocks so far this year. Both were held for more than a year, so they are long-term items. Long John had a gain of $1,000 on his investment in Fishing.com -- an Internet startup selling trout and salmon online to unlucky fishermen -- but a $600 loss on Fish-R-Us, a retailer of fish-shaped toys for kids. Subtract the loss from the gain, and we find that he has a net $400 long-term gain.
Now, let's say that he sells two more stocks before year's end. His investment in Mackerel Industries has turned out to be a real stinker. So he unloads it for a $300 short-term loss. And Minnow, Inc., turned a small short-term gain of $50. Net these two items together, and Long John has a $250 short-term loss.
Finally, we net the short-term items with the long-term items and find that Long John has a net $150 long-term gain.
If you think about it for a while, you'll find that everything will boil down to one of four situations:
- long-term gain with short-term gain
- long-term loss with short-term gain
- long-term gain with short-term loss
- long-term loss with short-term loss
Let's look at each of these situations.
Long-term gain with short-term gain
Ahhh -- investment nirvana! Everything nets out to a winner. Your taxes here are pretty simple. (Don't worry, though; they'll get more challenging as we go along.) The long-term gain gets the preferential rate of 10% or 20%, depending on your tax bracket. The short-term gain is taxed with your other income at your marginal rate.
Long-term loss with short-term gain
We have to look at two situations here. If the gain is bigger than the loss, you have a net short-term gain -- taxed at your marginal rate. If the loss is bigger, you have a net long-term loss. Up to $3,000 can be used to offset other kinds of income. Any unused amount will carry forward to the following year as a long-term loss.
Long-term gain with short-term loss
Again we have to consider two scenarios. If the gain is bigger than the loss, you have a net long-term gain and get to take advantage of the favorable rates for the net gain. If the loss is larger, it is a net short-term loss. Just like the previous situation, you can use up to $3,000 of that loss against other types of income, with any balance carrying forward to the next year as a short-term loss.
Long-term loss with short-term loss
Have you ever considered index funds? This one looks simple, but there's a twist. By now, you know that a maximum of $3,000 in losses will offset ordinary income. So, if the total of the two losses is less than $3,000, you're done. But what if the total loss is more than $3,000 and some must be carried over to next year? Is the carryover short-term or long-term? Well, it can be just long-term, or a combination of long- and short-term. But it will never be just short-term. Why? Because you must use the short-term losses first.
If your short-term losses are more than $3,000, you use the first $3,000 to offset ordinary income, then carry the remaining short-term loss along with all of the long-term loss over to next year. If the short-term loss is less than $3,000, you can just total the two losses together, take the $3,000 off, and the balance is a long-term loss carryover to the following year.
So, the process for determining the long-term or short-term character of your capital gains and losses can be summarized in three steps:
- Net your long-term items together.
- Net your short-term items together.
- Determine which of the above four situations applies to you, and follow the instructions there.
But what if you don't have any of one type of transaction -- either short-term or long-term? (Or, in a really unlikely situation, your long-term or short-term gains or losses net out to exactly zero?) The above instructions still work. Just consider the missing item to be a gain, and follow the same steps.
For more on the taxes that affect investors, read about:
- How 60 seconds can teach you the basics of taxes on investors.
- How to calculate your holding period for stocks and funds.
- What the wash sale rule is and how to deal with worthless stock.
- Why you have to pay attention to special tax rules for mutual funds.
- How to keep the tax man at bay.
FAQs
Losses on your investments are first used to offset capital gains of the same type. So, short-term losses are first deducted against short-term gains, and long-term losses are deducted against long-term gains. Net losses of either type can then be deducted against the other kind of gain.
Can you offset capital gains with losses for stocks? ›
Set off of Capital Losses
The Income-tax Act,1961 does not allow loss under the head capital gains to be set off against any income from other heads – this can be only set off within the 'Capital Gains' head. Long Term Capital Loss can be set off only against Long Term Capital Gains.
How long can you carry forward capital gain losses? ›
You can report current year net losses up to $3,000 — or $1,500 if married filing separately. Carry over net losses of more than $3,000 to next year's return. You can carry over capital losses indefinitely.
What to do if you have massive capital gains on a stock? ›
If you made significant gains in one stock, you can sell another at a loss and reduce your net profit. It's possible to use tax-loss harvesting to reduce your net capital gain all the way to zero. If you have more capital losses than capital gains, you'll have a net capital loss for the year.
How does the IRS know if you have capital gains? ›
Investment Transactions –– Gains from sales and trades of stocks, bonds, or certain commodities are usually reported to you on Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, or an equivalent statement.
Can you write off 100% of stock losses? ›
If you own a stock where the company has declared bankruptcy and the stock has become worthless, you can generally deduct the full amount of your loss on that stock — up to annual IRS limits with the ability to carry excess losses forward to future years.
Why are my capital losses limited to $3000? ›
The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated. The $3,000 loss limit rule can be found in IRC Section 1211(b). For investors with more than $3,000 in capital losses, the remaining amount can't be used toward the current tax year.
Can I use more than $3000 capital loss carryover? ›
The $3,000 limit is the amount of capital loss carryover that can be used to offset ordinary income. There is no limit on how much of the carryover can be used to offset capital gains. For example, suppose you have a $20,000 capital loss carryover from 2021 to 2022.
Is it worth claiming stock losses on taxes? ›
Those losses that you took in the previous calendar year in your portfolio can now be used to save you some money. When filing your taxes, capital losses can be used to offset capital gains and lower your taxable income. This is the silver lining to be found in selling a losing investment.
Do you pay capital gains after age 65? ›
This means right now, the law doesn't allow for any exemptions based on your age. Whether you're 65 or 95, seniors must pay capital gains tax where it's due.
In general, you can carry capital losses forward indefinitely, either until you use them all up or until they run out. Carryovers of capital losses have no time limit, so you can use them to offset capital gains or as a deduction against ordinary income in subsequent tax years until they are exhausted.
At what age do you not pay capital gains? ›
Capital Gains Tax for People Over 65. For individuals over 65, capital gains tax applies at 0% for long-term gains on assets held over a year and 15% for short-term gains under a year. Despite age, the IRS determines tax based on asset sale profits, with no special breaks for those 65 and older.
Can I reinvest my capital gains to avoid taxes? ›
Reinvest in new property
The like-kind (aka "1031") exchange is a popular way to bypass capital gains taxes on investment property sales. With this transaction, you sell an investment property and buy another one of similar value.
How do I pay zero capital gains tax? ›
A capital gains rate of 0% applies if your taxable income is less than or equal to:
- $44,625 for single and married filing separately;
- $89,250 for married filing jointly and qualifying surviving spouse; and.
- $59,750 for head of household.
Tax-loss harvesting allows you to sell investments that are down, replace them with reasonably similar investments, and then offset realized investment gains with those losses. The end result is that less of your money goes to taxes and more may stay invested and working for you.
How much capital gains can I offset with capital losses? ›
Capital losses that exceed capital gains in a year may be used to offset capital gains or as a deduction against ordinary income up to $3,000 in any one tax year. Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.
How do I offset capital gains tax? ›
How to Minimize or Avoid Capital Gains Tax
- Invest for the Long Term.
- Take Advantage of Tax-Deferred Retirement Plans.
- Use Capital Losses to Offset Gains.
- Watch Your Holding Periods.
- Pick Your Cost Basis.
By "netting" we mean that your total short-term losses are subtracted from your total short-term gains, and the result will be a net short-term gain or loss. Then, in Part II of Schedule D, you go through the same process with your long-term gains and losses. The result will be a net long-term gain or loss.
