Can You Deduct Stock Market Losses on Your Taxes?
The Basics of Capital Losses
The stock market or other kinds of investment are risky with unlimited potential for gains or losses. Gains are generally charged and the IRS allows deduction of the capital loss from taxable income. That’s some small consolation during downturns.
What Is a Capital Loss?
Capital losses may occur when an asset like stock or bond is sold for less than was originally paid. The amount by which the selling price is less than the purchase price is the capital loss.
How To Deduct Capital Losses
In order to actually deduct these capital losses on a tax return from their income, your taxpayer has to:
- Determine Loss: The first step is to calculate the difference between the purchase price and the selling price of the investment.
- Determine Deduction Type: The loss should be identified as either long-term or short-term:
- Short-term: Occurs in trades held in one year or less.
- Long-term: Refers to those trades that were held longer than one year.
- Gains Offsetting: Capital losses can be used as an offset to capital gains for that particular year. Say for instance you made short-term capital gains of $5,000 and short-term capital losses of $3,000, then that short-term capital gain would yield you a net short-term capital gain of $2,000.
- Deduct Against Ordinary Income: In the case of capital losses exceeding capital gains, the taxpayer can reduce ordinary income by up to $3,000 of net capital losses.
- Carrying Forward the Loss: You may carry forward any capital losses left beyond the $3,000 amount to subsequent tax years to offset capital gains in such years.
Other Important Factors
- Wash Sale Rule: The wash sale rule prohibits loss deduction on the sale of securities in case you buy substantially identical securities either within 30 days before or after the date of sale.
- Worthless Securities: In case a company files for bankruptcy, the stock will become worthless, and you may deduct a 100% loss in the year the stock becomes worthless.
- Points to Ponder While Reporting Losses: You have to report your capital gains and losses on IRS Form 8949 and Schedule D.
Let’s say you bought 100 shares of XYZ stock at $10 a share in January 2023. In December 2023, you sold the shares for $8 a share, resulting in a $200 short-term capital loss. If you have no capital gains to net against this loss, you could use the $200 to reduce your ordinary income on your 2023 tax return.
Tax Loss Harvesting
Tax loss harvesting is a strategy that cabbages selling lost investments to recognize capital losses and reinvesting in similar assets. This can be a tax-efficient way to run your portfolio and potentially lower taxes.
Conclusion
While stock market losses may be disappointing, their deduction from your taxes may provide a small amount of consolation. Knowing about these limits and rules of capital loss deductions would not only help you to maximize your tax benefit but also help you in making sound investment choices.
This article is for informational purposes. This is not to be construed as an advisory on financial matters or taxes. It is always advisable to seek independent financial and/or tax counsel from qualified professionals.
