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.
How much capital loss carryover can I use against capital gains? ›
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.
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 to unwind large capital gains? ›
Strategic Gifting
One less complex strategy for avoiding capital gains tax is to simply gift it to family or friends. As complex as estate planning can be (typically created for the purposes of after one's passing), another strategy may be to pass down cash or a portion of the portfolio while still living.
Can I offset all my capital gains with capital losses? ›
Key Takeaways
You can use capital losses to offset capital gains during a tax year, allowing you to remove some income from your tax return. You can use a capital loss to offset ordinary income up to $3,000 per year If you don't have capital gains to offset the loss.
How does the IRS know if you have capital gains? ›
Capital gain distributions are reported to the taxpayer on Form 1099-DIV. If there is no sale or disposition of capital assets to report, the Form 1099-DIV amount is reported directly on Form 1040 with a checkmark in the box to indicate a Schedule D is not required.
What is the 6 year rule for capital gains tax? ›
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
Why is capital loss limited to $3,000? ›
The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.
How to offset capital gains with losses? ›
Essentially tax loss harvesting is when you purposefully sell assets at a loss. In turn, the losses from those investments' gains let you offset your gains elsewhere in your investment portfolio and if you have enough losses, reduce your ordinary income, and in turn, potentially your tax bill.
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.
Whether you're 65 or 95, seniors must pay capital gains tax where it's due. This can be on the sale of real estate or other investments that have increased in value over their original purchase price, which is known as the “tax basis.”
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. By doing so, you can defer owing capital gains taxes on the first property.
How much stock loss can you write off? ›
No capital gains? Your claimed capital losses will come off your taxable income, reducing your tax bill. Your maximum net capital loss in any tax year is $3,000. The IRS limits your net loss to $3,000 (for individuals and married filing jointly) or $1,500 (for married filing separately).
Is there any way to offset capital gains tax? ›
Utilize tax-loss harvesting
This strategy involves selling underperforming investments and booking a loss. You can use these capital losses to offset taxable investment gains and up to $3,000 each year of ordinary income.
How long to hold stock to avoid capital gains tax? ›
By investing in eligible low-income and distressed communities, you can defer taxes and potentially avoid capital gains tax on stocks altogether. To qualify, you must invest unrealized gains within 180 days of a stock sale into an eligible opportunity fund, then hold the investment for at least 10 years.
Can you offset capital gains losses against income tax? ›
Losses made from the sale of capital assets are not allowed to be offset against income, other than in very specific circ*mstances (broadly if you have disposed of qualifying trading company shares). You cannot claim a loss made on the disposal of an asset that is exempt from capital gains tax (CGT).
What is the maximum capital loss allowed by the IRS? ›
You can deduct capital losses up to the amount of your capital gains plus $3,000 ($1,500 if married filing separately). You may be able to use capital losses that exceed this limit in future years. For details, see the instructions for line 21.
Why are capital losses limited to $3,000? ›
The $3,000 loss limit is the amount that can be offset against ordinary income. Above $3,000 is where things can get complicated.
How can I offset capital gains tax? ›
To limit capital gains taxes, you can invest for the long-term, use tax-advantaged retirement accounts, and offset capital gains with capital losses.
