When it comes to investing, you can expect to experience both gains and losses. You might even incur a capital loss on purpose to get rid of an investment thats making your portfolio look bad. And while selling an asset at a loss may not seem ideal, it can benefit you at tax time. Besides lowering your taxable income, a capital loss may also help you snag a deduction.
A financial advisor can help you optimize a tax strategy to reach your investing goals.Find a financial advisor today.
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What Is a Capital Loss?
A capital loss occurs when you sell a capital asset for less than what you bought it for. Capital assets include stocks, bonds, homes and cars.
Any expenses from the sale of an asset count toward the loss amount. Youmay be able to claim a capital loss on an inherited property, too, if you sold it to someone whos not related to you and neither you nor your family members used it for personal purposes.
Its important to remember that capital losses (also known as realized losses) only count following a sale. So just having a stock decrease in value isnt considered a capital loss even if you hold on to it. An asset that you keep after its price has fallen is called an unrealized loss.
Realized gains (or profits from the sale of an investment) should always be reported to the IRS using Form 8949 and Schedule D. Youll also use Schedule D to deduct your capital losses. Realized losses from the sale of personal property, however, do not need to be reported to the federal government and usually arent eligible for the capital loss tax deduction.
The Capital Loss Tax Deduction
The capital loss deduction gives you a tax break for claiming your realized losses. In other words, reporting your losses to the IRS can shrink your tax bill.
How much you candeduct depends on the size of yourgains and losses. If you end up with a larger capital gain amount, you can subtract your losses from your gains.This lowers the amount of income thats subject to the capital gains tax.
What happens if your losses exceed your gains? The IRS will let you deduct up to $3,000 of capital losses (or up to $1,500 if you and your spouse are filing separate tax returns). If you have any leftover losses, you can carry the amount forward and claim it on a future tax return.
Short-Term and Long-Term Capital Losses
Capital gains and losses fall into two categories: long-term gains and losses and short-term gains and losses. If you sell an investment you owned for a year or less, its considered a short-term gain (or loss). If you sell an asset youve held for over a year, it counts as a long-term loss or gain.
These classifications come into play when calculating net capital gain. In order to use your losses to offset your gains, you must first group them together by type.Short-term losses must initially be deducted from short-term gains before you can apply them to long-term gains (and vice versa).
Short-term capital gains are taxed like ordinary income. That means your tax rate might be as high as 37%. And depending on your income, you might also owe a 3.8% Medicare surtax.
Tax rates for long-term capital gains, on the other hand, are generally much lower. If youre in the 10% or 15% tax bracket, you wont owe any taxes if you have long-term capital gains. If youre in a higher tax bracket, youll face a 15% or 20% tax rate.
You may want to consider selling your assets at a loss when you have short-term capital gains (or no gains at all). That way, youll minimize your tax bite and eliminate low-performing investments at the same time.
The Wash-Sale Rule
If youre a savvy investor, you may be tempted to take advantage of tax loopholes. Some think they can sell a deflated stock and then immediately buy back the same stock or a similar security. That way, they can deduct a capital loss on their tax return while their portfolio remains relatively unchanged.
That may seem like a good plan. But if you put it into practice, youll be breaking the wash-sale rule. This rule says that if you sell a security at a loss, you cant buy it back (or buy a stock thats nearly identical to the one you sold) within the 30-day period before or after the sale. If you break the rule and get caught, youll have to add the loss to the cost of the new stock you purchased.
To work around the wash-sale rule, you can sell shares of one companys security and pick up the same type of fund from a different company. To avoid the wash-sale rule in bond trading, its best to make sure your new bond differs from the original bond in at least two ways. For example, your new bond may need to have a different rate, maturity or issuer.
Selling an asset at a loss isnt the worst thing in the world. In fact, some investors deliberately incur capital losses to lessen their capital gains tax bite. If youre trying to use a capital loss to offset your gains, just remember to follow the rules so that you can qualify for a tax break.
Tips for Investing
- Investing isnt an exact science, and youre likely to incur losses at some point along the line. A financial advisor can help you manage your investments.SmartAssets free tool matches you with financial advisors in your area in 5 minutes. If youre ready to be matched with local advisors, get started now.
- SmartAsset has lots of free online investment resources available for you to take advantage of. For example, check out our investment calculator and get started investing today.
- While you research your options, you could always stash the cash in aninterest-yielding savings account. Youll earn interest while deciding if you want to find a longer term investment. And the best part is you can withdraw the money at any time.
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