Capital Loss Tax Strategy Requires Planning

Just because a loss is sustained does not mean nothing can be recouped.  But investors should have the entire picture before making moves in this area.

Monetary benefit comes from capital losses in the form of taxes you would have paid without those losses.  Figuring your tax rate is complicated.  But a lot of capital gains are taxed at 15%.  So for the sake of argument let us use that figure.  If you had a $20,000 stock market gain in a given year and you offset that with a $20,000 stock market loss you would be saving $3,000 in taxes ($20,000 X .15).  In simplest terms: You would get your $20,000 gain tax free and recover 15% of the loss on the other transaction.  It is better not to incur a loss of course.  But this way you reap some benefit.

If your capital losses exceed your capital gains, the amount of the excess loss can be claimed on line 13 of Form 1040.  That means it goes in with the items that make up your total income.  Other examples of these items include stock dividends, bond interest and W2 earnings. Naturally, because a loss is being added, your income will be directly reduced by whatever that loss is.  The amount allowed is the lesser of $3,000 ($1,500 if married filing separately) or your total net loss shown on line 16 of Form 1040, Schedule D. If your net capital loss is more than this limit, you can carry the loss forward to later years.

Once it is carried over to the next year the process begins again.  First you can subtract any new losses, then your carryover losses, from your gains.  Any remainder can then be applied to your total income calculation up to the limit.  After that anything left again can be moved forward to the next tax year.

It is key to remember that capital losses are only applied to capital gains of the same type.  Short term capital losses (on securities held one year or less) are applied against short term capital gains. Long term capital losses (on securities held more than one year) are applied to long term capital gains.  The same goes for carryover losses.  A short term carryover loss, for instance, must be applied to a shot term gain in future years.

A few years ago I cleared some capital loss carryovers off the books.  There were both short term and long term carryover losses.  So I had to make sure the securities sold at a profit were characterized the same way.  If they were not some of the losses would have remained, taxes would have been paid on some of the gains, and the strategy would have failed.

There is also an important limitation to keep in mind.  Capital losses cannot be carried over after a taxpayer’s death. They are deductible only on the final income tax return filed on the decedent’s behalf. The $3,000 yearly limit discussed earlier still applies in this situation. Even if the loss is greater than the limit, the decedent’s estate cannot deduct the difference or carry it over to following years.

Investors, therefore, may want to give thought before letting loss carryovers pile up.  If you sustain a substantial loss give some thought to selling something with a substantial profit to offset it.  Keeping a large stockpile of carryover losses means that any benefit disappears in the case of a tragic situation.

A little planning is required to successfully execute capital loss strategies.  It is probably fairly common knowledge that losses can be taken against gains.  But without factoring in some finer points the outcome might not be as desired.


© 2017 – Essentials of Investing

Articles presented here are general opinions for your own consideration. They are not specific advice for any one investor.

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