Capital loss is not something an investor might want to hear, but it’s not a completely hopeless situation. In fact, a capital loss can be claimed on your tax return to decrease the tax amount you owe the IRS. More importantly, it can be carried over to following years if not used up in the current year.
This article will explain to you in detail how capital loss carryover works and how it can benefit your small business.
Definition of capital loss carryover
Let’s start first with net capital losses.
Net capital losses are the difference between total capital losses and total capital gains, which are tax-deductible. The trick is you can only deduct a maximum of $3,000 every tax year, or $1,500 if married filing separately.
So what happens if you have more than $3,000 net capital losses?
When capital losses exceed the limit, the IRS allows investors to carry them forward to subsequent fiscal years until they are depleted. There is no limit on how long the capital losses can be carried forward, but, just to note, you can’t choose which year the carryover loss would be offset. If you leave a year without offsetting the loss, the forfeit is permanent.
The net amount of capital losses that can be carried over into future tax years is known as capital loss carryover.
Examples of capital loss carryover
To help you better understand the concept of capital loss carryover, here are a few examples below.
Let’s say your net capital loss in 2021 was $8,000. If you have no capital gains for 2022 and 2023, you can deduct $3,000 of the loss on your 2021 return, $3,000 on your 2022 return, and the remaining $2,000 on your 2023 return.
In the case where you have an $8,000 capital loss, but you also have an $8,000 capital gain from the sale of another investment, the gain and the loss would offset each other on your tax return. In this situation, you would have no tax loss remaining to carry over to the next year.
You can’t choose to pay tax on the gain this year and move the loss to the following year. Your capital losses must first be used to offset any capital gains of the same type in the current tax year.
Suppose you sold a stock and realized a $15,000 loss with no capital gains in a particular year. You’d use $3,000 of the loss to offset your ordinary income. The remaining $12,000 will carry over to the following year.
In that year, if you had $8,000 of capital gains, you could use the $8,000 of your remaining $12,000 loss carryover to offset it, leaving $4,000. You can then use another $3,000 to deduct against ordinary income, which would leave you with $1,000.
The remaining $1,000 would then carry forward to the next tax year.
You might also be interested in:
- Capital Expenditure: An Ultimate Guideline For Small Businesses
- Your Complete Guide to the IRS Tax Deduction Calculator
How to claim a capital loss carryover?
Form 8949 is to help you report any capital asset transactions. You’ll list in detail what the asset is, when you acquired the asset and when you sold it, as well as how much it cost and how much you sold it for.
Once you’ve finished filling in all the entries to Form 8949, transfer the subtotals to Schedule D.
Your total net loss will appear on line 16 of Schedule D. If that figure exceeds $3000 or $1500 limits, that’s when you know what your capital loss carryover to the following years is.
Helpful tip: Capital loss carryover worksheet
The IRS offers a Capital Loss Carryover Worksheet to help you figure out whether you have a capital loss carryover or not. You can find the worksheet in both Publication 550 and 2021 Instructions for Schedule D for guidance. The worksheet is easy to follow, with comprehensive instructions on every line, so try it out to calculate your capital loss carryovers!
Capital loss carryover worksheet from Publication 550.
Capital loss carryover worksheet from 2021 Instructions for Schedule D.
BONUS Info: The tax loss harvesting strategy
Investors have been leveraging the capital loss policy of the IRS for years to lower their taxable income and better allocate their investments. The strategy is called tax-loss harvesting.
Essentially, you sell investments for a loss and then offset the loss with your capital gains. As you already know from the section above, you can offset and lower your taxable income up to $3000 a year, and any unused capital loss can be carried forward for future years.
To research more on this strategy, you can read this article.
Capital loss is not good news for your investments, yet you still can take advantage of it for tax purposes. You can deduct up to $3000 on your tax bill and carry the excess amount forward over the years till your capital loss is totally used up.
Make sure to use the IRS’s provided worksheet to calculate your capital loss carryover accurately.
If this article is helpful for you, check out the Shoeboxed Blog for more similar financial content!
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