Capital Losses and Tax Planning

NOTE: I wrote this post in 2013, but its content is still accurate today.

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The following question came up recently: 

An investor has a $10,000 capital loss carryforward from prior years. They have $5,000 of capital gains from stock sold this year. How does the loss carryforward work this year?

Background

Tax law places limits on how much a taxpayer can deduct in capital losses each year. The limit is $3,000 of losses per year. Any unused losses beyond $3,000 are carried forward to be used, $3,000-at-a-time, in future years.

For more on stock losses and taxes, see this recent blog post.

Answer

Here’s the answer to the question posed at the start of this post.

The taxpayer has $10,000 of unused losses from prior years. These losses off-set all of their current-year capital gains. Plus, the taxpayer can take an additional deduction of $3,000 so that they get to their limit of a maximum of a $3,000 loss deduction for the year year.

So the end result is that their tax return would show a $3,000 capital loss deduction, with $2,000 of unused losses to carry forward to next year.

The $2,000 is arrived at as: $10,000 beginning loss, minus the $5,000 of current-year gains that are essentially “neutralized,” minus the additional $3,000 of capital loss the taxpayer is allowed to take = $2,000 loss remaining to be used in the future.

Image courtesy of David Castillo Dominici / freedigitalphotos.net