Tax Laws Regarding Losses in the Stock Market

Losses in the stock market can be deducted from taxable income.

Losses in the stock market are called capital losses and are regulated by Title 26 of the United States Code. Tax law contains many categories and sub-headings within Title 26. For example, the law governing capital losses is contained within Subtitle A, Chapter one, Sub-chapter P, sections 1211-1260. According to section 1211 of Sub-chapter P, only $1,500.00-$,3000.00 in capital losses can be deducted from taxable income each year.

Carry-overs

Capital loss in excess of the maximum deduction can be deferred to subsequent tax years.

Capital loss carry-overs are an aspect of tax law that allow stock losses to be applied to future taxes as a deduction. Carry-overs are illustrated in section 1212 of sub-chapter P. These deductions can reduce subsequent years taxes or increase refunds for those years. Carry-overs can be used for as many years at it takes to exhaust the capital loss via tax deductions.

Carry-backs

Carry-backs allow a tax deduction to a year for which a tax return may have already been filed. In other words, the loss from the sale of stock can trigger a refund on previous taxes paid. Carry-backs can be applied to tax returns up to three years prior to the tax year in which the loss was incurred. The tax law governing carry-backs is contained in the same section regulating carry-overs.

Wash sales

Wash sales occur when the same or related stock shares are bought or sold 30 days before or after the sale of stock for which there was a capital loss. The wash sale law prevents investors from deducting their loss when previous or subsequent investing offsets the loss. This tax law is also contained within U.S. Code, Title 26, but in Sub-chapter O of sub-title A, it specifies which capital losses are defined as non-deductible wash sales.

IRAs

Stock market losses cannot be deducted when the stocks are sold through some retirement accounts. This is because taxes on these types of accounts are deferred until payments are received from them. The Internal Revenue Service does allow capital losses to be deducted after funds are completely withdrawn from accounts, such as the Roth IRA. These funds must be less than the total non-deductible cash contributions made to the account.

Holding periods

The time stocks are held determine how capital losses affect tax.

Capital gains held less than a year are subject to a higher capital gains tax than capital assets sold after one year. Short-term capital losses offset the higher tax on short-term capital gains. The tax rate on short-term capital gains can be adjusted with new legislation. For example, the Economic Growth and Tax Relief Reconciliation Act of 2001 lowered capital gains taxes.

References

• Internal Revenue Service: Capital Gains and Losses
• U.S. House of Representatives: 26 USC Chapter 1
• Cornell University Law School: U.S. Code Title 26, Subtitle A, Capital Gains and Losses
• Justia US Laws: Loss from wash sales of stock or securities
• Tax Guide for Investors: Capital Gains and Losses 101

Resources

• U.S. Government Printing Office: Economic Growth and Tax Relief Reconciliation Act of 2001
• IRS: Sales and Trades of Investment Property
• Smart Money: Understanding Wash Sale Rules
• Google Books: 2009 U.S. Master Tax Guide
• Sheppard, Brett, Stewart, Hersch, Kinsey & Hill P.A.: Step Up in Tax Cost Basis is the Big Deal