5 Things to Know About Tax Losses

This year—2022—has been a tough time for profits in securities, realty, and other assets. Tax rules may allow for write-offs, but not in all situations. Here are 5 things to know.

1. Capital losses offset capital gains

Losses on the sale or exchange of capital assets held for investment are treated as capital losses—short term or long term depending on how long the assets were held. Capital losses offset capital gains (there is an ordering rule for applying which types of capital losses against which types of capital gains). Ultimately, any capital loss can be used to offset any type of capital gain: short-term capital gain taxed up to 37%, long-term capital gain taxed at zero, 15%, or 20%, gain on unrealized depreciation taxed up to 25%, and gain on Section 1202 stock (not otherwise excluded) and collectibles taxed up to 28%.

2. Capital losses may generate an offset to ordinary income

If capital losses exceed capital gains, the excess can offset up to $3,000 of ordinary income ($1,500 for married persons filing separately). For example, if there is an excess $3,000 loss, the deduction for the capital loss can effectively make $3,000 of wages tax free.

3. Capital losses can be carried forward indefinitely

Unused capital losses in excess of the $3,000 cap aren’t lost; they can be carried forward and used in future years. The carryforward is first applied against capital losses in the carryforward year. Any exceesscan be used as an ordinary income offset, explained above.

For joint filers, the carryover is lost after the year of the death of a spouse who individually owned the assets that triggered the loss. In other words, a point return may be filed for the year of death, and a capital loss carryforward from a prior year may be used on the joint return. In the following year, the surviving spouse may not use any carryover attributable to the deceased spouse. But if the asset was owned jointly in both spouse’s names, half the loss may be carried forward indefinitely by the surviving spouse.

Investors with loss positions in their holdings may wish to take those losses now and “bank” them for use as offsets in future years. Before doing this, consider the advisability from an investment perspective, any transaction costs, and the impact of the wash sale rule (discussed later).

4. Wash sale rule limits current losses

If substantially identical securities are purchased within 30 days before or after a sale that results in a loss, the loss may not be recognized in the year of the sale. However, the loss is not lost; a disallowed loss increases the basis of the replacement securities which will reduce a gain or increase a loss on a future taxable sale.

5. No deduction for losses on personal-use property

Homeowners who sold their residences at a loss experienced an economic loss but not a tax loss. That’s because no deduction is allowed on losses arising from sales of personal-use property. This rule also applies to losses on other personal-use property, such as a car or even household items sold at garage sales or online platforms.

Conclusion

Losses reduce your net worth—you take an economic hit. But tax rules in some situations can ease the pain by reducing your tax bill.