How Do Stock Losses Go Against Gains for Taxes?

Stock losses can cut your tax bill.

Losing money on stock investments is not a good thing in any respect, except one: The only positive about a stock loss is that U.S. income tax rules allow you to use investment losses to offset investment gains. So, when tax time comes, pull out your stock trading records and statements, and use your stock losses to help reduce the tax bite.

Types

Profits and losses from the sale of stock are called capital gains and capital losses. Both gains and losses must be divided into short-term and long-term categories. Long-term capital gains and losses are from stocks owned for longer than one year. Short-term gains and losses result from stocks that were owned for one year or less.

Offsets

For tax purposes, long-term losses are first offset against long-term gains, and short-term losses are calculated against short-term gains. If the long-term losses are less than the long-term gains, there is a net long-term capital gain. If the long-term losses are greater than the long-term gains, a net long-term capital loss ensues. The short-term gains and losses are offset in the same way, to result in a net short-term gain or loss.

Taxable Gains

Net long-term capital gains are taxed at a lower rate than other income. Net short-term gains are taxed at the tax payer's regular tax rate. If there is one gain and one loss after offsetting the long- and short-term results, the loss will be offset against the gain. If the total capital losses exceed the gains, up to $3,000 in capital losses can be deducted against other forms of income. Extra losses in excess of $3,000 can be carried forward to future tax years.

Considerations

Long-term capital gains are taxed at a significantly lower rate than other forms of income. It is best to offset long-term capital gains only with long-term losses. Short-term losses can be used to offset short-term gains and other income that is taxed at the taxpayer's highest tax rate. The order of offsetting gains is set by law and not flexible. An investor should consider the tax implications when timing stock sales to realize gains or losses.

Warning

If an investor sells a stock at a loss and buys it back within 60 days, that is called a wash sale, and any loss realized from the sale cannot be deducted from gains or income. If a stock is sold at the end of the year to generate a tax loss, it cannot be repurchased until at least two months after the sale.

References

• IRS: 10 Facts About Capital Gains and Losses
• Bankrate: Capital Losses Can Cut Taxes