Are There Limits to Stock Loss Deductions?
The Internal Revenue Service classifies all property that you hold as an investment or for personal use as a capital asset. Capital assets include all stock you hold in public and private companies. Unlike other deductible expenses, losses that result from the sale or trade of a stock have limited usefulness in reducing your overall taxable income each year.
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Stock Basis
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The tax basis of the stock you own directly affects the amount of loss a sale may generate. The stock's tax basis is equal to the price you pay for it plus additional expenses you incur to acquire it. These additional expenses can include brokerage commissions, recording fees and transfer fees. If you acquire the stock as a gift, the tax basis is equal to the donor's tax basis immediately before you receive the stock. If you receive additional shares of a stock you already own in a stock split, you must reallocate the basis of the initial stock purchase to all shares of stock you own after the split. For example, if you purchase a share of XYZ Corporation for $120 and receive an additional two share after the split, the basis of each share is now $40.
Calculating Losses
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When you sell shares of stock, you calculate the gain or loss by subtracting the stock's tax basis from the amount you realize on the sale. The amount you realize on a sale includes all money and property you receive. If a brokerage firm requires you to pay a commission on the sale, reduce the amount you realize by the brokerage fee. To illustrate, suppose you purchase a share of stock for $100 and pay a brokerage fee of $10; the resulting tax basis is $110. If two days later you sell the stock for $110 and incur another $10 brokerage fee, the amount you realize on the sale is $100. At the end of the year, you have a net capital loss of $10.
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Deducting Losses
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The loss you incur on the sale of a stock can offset an unlimited amount of capital gains you generate during the year. If the losses for the year exceed gains, a maximum of $3,000 of the excess is deductible from other ordinary taxable income, such as interest and employment income. If losses still remain, you can carry them forward to future tax years to offset capital gains and $3,000 per year as an ordinary income deduction. However, the IRS requires that losses you carry forward offset all capital gains before you can take an ordinary deduction.
Reporting
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Each year that you sell a stock, you must complete the Schedule D attachment to IRS Form 1040. The Schedule D requires you to provide the tax basis and amount realized for each stock transaction. You must also separate short-term capital transactions from long-term capital transactions. Short-term capital transactions are stocks you own for one year or less, with the remainder classified as long-term capital transactions. It is important to retain prior year schedule to keep track of capital loss balances.
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