Tax Deductions for Stock Loss
A bad investment can have a silver lining. Their can be some relief at tax time, and it may be better to realize a loss now than to wait on an uncertain outcome. Many taxpayers rely on their tax preparer or on software to account for these events without truly understanding the capital gains/loss rules and process.
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Facts
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IRS Code has a provision within it to allow a tax filer to receive a benefit from a loss on any capital investment. Currently, tax filers can reduce taxable income by the amount of their loss or $3,000--whichever is smaller--if filing married/jointly, or as a single filer. Those who are married filing separate returns can each deduct $1,500 from their income. In either situation, this reduces the overall tax liability. Schedule D of IRS Form 1040 is the form used to calculate gains and losses. Those results are then transferred to Form 1040, itself.
Significance
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Having the ability to deduct these losses allows an investor to be able to eliminate an investment which does not meet expectations or no longer has the prospects of doing so. The tax benefit is realized in the year that the asset is sold. If more than one asset fails, all losses can be used, up to the allowable limit. These losses can also be used to offset gains in successful transactions.
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Effects
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Examples will help illustrate the process:
Investor "A" has $40,000 in taxable earnings and $10,000 in realized gains from sales of successful trades this tax year, but he chooses not to sell his losers. His combined taxable income is now $50,000. This is good, but now taxes are paid on a greater amount of income, and he still owns losing trades.
Investor "B" has $40,000 in taxable earnings and $3,000 in realized losses from sales this tax year. Her taxable income is reduced to $37,000. Her tax liability may be reduced, however, since her income is reduced. Any losses greater than $3,000 will be applied to the next year's tax bill as a tax loss carry-forward. That is also a benefit.
Considerations
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Tax filers who have investment accounts need to be aware of these rules. While these examples are simplified, there are additional losses that may be allowed. It is also important to know that Schedule D accounts for both short-term and long-term holdings. Short-term applies to anything held less than one year, and it gets a different tax-rate treatment. Additionally, IRAs and other retirement plans are excluded from these tax considerations since they are already tax-advantaged. These IRS-approved deductions apply to taxable accounts only.
Benefits
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With some attention, managing winning trades against losing ones can improve results. Pairing off losers against winners offsets the taxes due on the winners and gets poor performers out of your account. Accumulating more losses than allowed in the current tax year can be "banked" against future income or capital gains.
Understanding the process and the reasoning for taking tax losses can improve overall tax planning and investment success.
As always, consult a tax professional.
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