What is a Capital Loss Tax Deduction?
This article has been updated for the 2023 and 2024 tax years. The tax implications of selling an investment are usually thought of and discussed in a negative light. At the same time, selling an investment for a loss is almost universally seen as a bad thing. Well, it turns out that even in this situation, there can be a silver lining: a capital loss tax deduction.
If you’ll recall, capital gains taxes must be paid on gains when an investment is sold. Short-term capital gains (for investments held for less than one year) are taxed at ordinary income tax rates – basically whatever marginal tax bracket the income falls into. Long-term capital gains, meanwhile, are taxed at a preferential discounted rate. The capital gains rates are as follows for 2023 and 2024:
2023 Short-Term Capital Gains:
|Ordinary Income Tax Rates (2023)||Single Filer Tax Brackets||Married Filing Jointly Tax Brackets (& Surviving Spouses)||Married Filing Separately Tax Brackets||Head of Household Tax Brackets|
2023 Long-Term Capital Gains:
|Long-Term Capital Gains Tax Rates (2023)||Single Filer Tax Brackets||Married Filing Jointly Tax Brackets (& Surviving Spouses)||Married Filing Separately Tax Brackets||Head of Household Tax Brackets|
2024 Short-Term Capital Gains:
|Ordinary Income Tax Rates (2024)||Single Filer Tax Brackets||Married Filing Jointly Tax Brackets (& Surviving Spouses)||Married Filing Separately Tax Brackets||Head of Household Tax Brackets|
2024 Long-Term Capital Gains:
|Long-Term Capital Gains Tax Rates (2024)||Single Filer Tax Brackets||Married Filing Jointly Tax Brackets (& Surviving Spouses)||Married Filing Separately Tax Brackets||Head of Household Tax Brackets|
When you sell an investment for a gain, you pay taxes on the gain. But when you sell at a loss, you get to deduct the loss from your taxes. This is a capital loss tax deduction.
Fortunately, capital losses have no such distinction in tax rate as highlighted in the table above. Whether you’ve held an investment for 10 days or 5 years does not matter – your deduction comes off your last earned dollars, at your top marginal tax rate – which can result in a sizable tax deduction and savings for you.
A Capital Loss Deduction Example
Let’s take a look at an example so you can see what I’m talking about. Let’s say you buy 100 shares of “Chatch & Sons, Inc.” for $150. Months later, Chatch & Sons CEO and founder, Chatch McGee, holds a press conference to announce that he had improper relations with dozens of interns. Newborns and lawsuits are popping left and right. The stock tanks to $120. The future of Chatch & Sons does not look good. You decide to sell, and are left with proceeds of $12,000. This results in a capital loss of $3,000 ($12,000 proceeds minus the original $15,000 cost).
Meanwhile, your income tops out well into the marginal 32% tax bracket. Assuming you had no other capital gains or losses, how much did selling your stock save you in taxes paid?
$3,000 x 0.32 = $960
By getting rid of a bad investment, you were able to claw 32% of your loss back, just by virtue of the fact that you fell in to that higher tax bracket. And now you can wisely move your remaining funds over to a much more diversified passive investment like an ETF or index fund. ;-)
If you did have capital gains during the year, you would subtract your capital losses from the capital gains before subtracting as a deduction from ordinary income.
Capital Loss Limit and Capital Loss Carryover
There is a deductible capital loss limit of $3,000 per year ($1,500 for a married individual filing separately). However, capital losses exceeding $3,000 can be carried over into the following year and subtracted from gains for that year. This is called a capital loss carryover and you can actually continue carrying over the capital loss until it is 100% used up. If you make capital gains in the subsequent years, the remaining losses can cancel out the gains. And if you have additional capital losses, you add those to carried over losses. You can keep carrying over the capital loss balance to future years until it is completely depleted (note: the amount you can deduct, however, is based on your tax rate for that present year).
When Capital Loss Tax Deductions are the Most Valuable
Being able to deduct from your income to save money on taxes is always a welcome thing, but it is especially welcome and valuable in a few different scenarios:
- you’re having a great year income wise that pushes you in to a higher tax bracket than normal (e.g. big commissions, a huge bonus, you won a small lottery, etc.)
- you’re in a high tax bracket, but anticipate that in the coming years you’ll be in a lower one (due to retirement, a change in job, etc.)
- you have company stock, but the stock is a big under-performer compared to the overall market
- you currently live in a high income tax state and anticipate moving to a lower income tax state
In other words, take those losses when they are worth the most to you as a deduction!
And if the opposite is true:
- you’re in a lower tax bracket than normal (i.e. a low commissions, no bonus, high deductions, etc.)
- you anticipate that in the coming years you’ll be in a higher tax bracket (e.g. due to a higher education, more experience, higher paying job, etc.)
- your company stock is performing better than average, and you don’t anticipate that changing in the near term
- you currently live in a low income tax state and anticipate moving to a higher income tax state
… then you may want to re-consider taking the losses, and saving them for future tax years. Of course, if the investment is an absolute sinking ship, then you may not have that luxury. Just make sure you are aware of IRS and SEC “wash sale” rules, where you basically can’t claim a loss on your original sale if you buy back the same (or similar) equity within 30 days from selling.