C is for Capital Losses.
We hear a lot in the tax world about capital gains. But what about its counterpart, capital losses? You don’t see a lot written about losses because, let’s face it, they’re a bit of a downer. Nobody wants to talking about losing money. It’s much more fun to talk about making money. But there’s not a week doesn’t go by that I don’t receive at least two or three emails asking about capital losses. So, grab your antidepressants… we’re talking capital losses.
Capital gains and capital losses are figured on capital assets. And despite how the economists define capital assets, the IRS defines them as “[a]lmost everything you own and use for personal or investment purposes is a capital asset.” Clears it right up for you, huh?
Let me put it a different way… For non-business purposes, individual taxpayers should think of capital assets as nondisposable assets. In other words, things of value that you intend to sell or keep for investment or use. That would include stocks and bonds (what most people think of when they think of capital assets), furniture, cars and real estate – and yes, that means your home. If it’s intended to eventually be disposable – like food or clothing – it’s generally not considered a capital asset. That analysis is a bit simplistic but you get the picture.
When you sell or otherwise dispose of a capital asset, the difference between the amount you sell it for and your basis is a capital gain (if the value at disposition is more than your basis) or a capital loss (if the value of the disposition is less than your basis). Basis is, at its most simple, the cost that you pay for assets plus adjustments.
Most taxpayers understand that you must report all capital gains. We hear about favorable tax treatment for capital gains all of the time.
But what about losses? The Tax Code isn’t so forgiving when it comes to losses. You can only deduct capital losses on investment property, not on personal use property. That means that you can’t deduct the hit you took on your personal residence, no matter how bad it felt. And that Hummer that lost its value the second you drove it off the lot? Also not a loss for tax purposes.
Investment property is a different story. You may claim a capital loss on investment property (think stocks and bonds and certain kinds of real estate) depending on the nature of the loss and whether you have offsetting gains. Like capital gains, capital losses are classified as long-term or short-term. If you hold the property more than one year, your capital gain or loss is long-term. If you hold it one year or less, the gain or loss is short-term.
Generally, you can deduct your long-term losses from your long-term gains.
If your gains are bigger than your losses (and we hope they are), you have a net capital gain. You would then subtract any short-term losses from the net capital gain to calculate the net capital gain you must report and pay tax on.
But what if your capital losses exceed your capital gains? If that happens, you can use the capital losses to offset other income, like wages, but only up to $3,000 (or $1,500 if you are married filing separately) in a tax year. If you have more than that amount – and gosh, I hope that you don’t – you can carry the excess forward to the next year, subject to certain restrictions, and hope for better luck next time.
You’ll report your gains and losses on a federal form 8949, Sales and Other Dispositions of Capital Assets (downloads as a pdf), and then transfer that information to Schedule D before (take a breath) moving those results to the reconciliation page on your federal form 1040.
Here’s the really important part: a gain or loss has to be realized in order to mean anything for tax purposes. Just because the market or your portfolio goes up or down doesn’t result in a capital gain or loss. A triggering event has to happen to result in an actual capital gain or loss. When the market tanks or real estate values plunge, it may feel like you’ve lost something, but there no capital loss for tax purposes unless you actually realize the loss by selling, transferring, disposing, abandoning or otherwise walking away from the asset.
So not too confusing, right? Keep in mind, though, that some assets have special rules – like artwork, collectibles and small business stock – so pay attention to the fine print. If you’re dealing with capital gains and losses beyond publicly held stocks, definitely check with your tax professional. Don’t think, however, that you have to save the tricky assets for discussion – even “regular” capital losses can be mitigated with some smart tax planning.
For more in the series, see: