Taxation of Capital Losses

Taxation, as a whole, is monies paid to a government or municipality.

Taxation, as a whole, is monies paid to a government or municipality. Taxation of Capital Losses is income taxes due on capital losses which are paid to the Internal Revenue Service (IRS). Technically speaking, you can’t pay taxes on money you don’t have; in other words, you can’t be taxed on the money you lost. However, capital losses are figured into the income tax mix as a deduction from, not an addition to, the annual taxable income. To find out what those taxes are takes more than one mathematical process.

What Is Capital?
According to the IRS, in general everything you own or use for personal purposes, pleasure, or investments (for example motorcycles, boats or RVs) are capital or capital assets. Specifically, capital assets include the following items:

stocks or bonds held in a personal account
a house owned and used by the owner and his/her family
household furnishings
a car used for pleasure or commuting
coin or stamp collections
gems and jewelry
gold, silver, or any other precious metal

The sale of each of these items must be compared to the purchase price to determine if there is a capital loss or gain.

What Are Capital Losses?
Capital losses are losses incurred through the sale of a capital asset when it is sold for less than its purchase price. According to the IRS, the difference between what the asset sold for and what it was bought for is considered a capital gain or loss. If the asset sold for less than what was paid for it, the difference is a loss; if it sold for more than what was paid for it, the difference is a gain. While capital gains, both investment and personal, must be reported as income to the IRS, only capital losses on investment property, not personal property, can be deducted.

How Is the Tax Determined?
If the capital losses exceed the capital gains, the amount of the excess loss that can be claimed is limited to $3,000 or $1,500 if a married couple are filing separately. If the net capital loss is more than this limit, the loss can be carried forward to later years. To determine the amount carried forward use the Capital Loss Carryover Worksheet in IRS Publication 550.

How to Use Your Losses
Holding onto a price deflated stock has no real tax determent, until it’s sold and the difference is taken as a loss. Some financial investors believe this to be a positive as the loss can be taken to offset capital gains in other investments and in turn cut the overall tax bill.

The Math for Taxation of Capital Losses
One loss does not equal one deduction. One loss is just one part of the overall picture of available deductions which may or may not be offset with gains. The situation gets a bit complicated at this point, and the whole picture should be taken into account. This is the big picture on an IRS reporting form Schedule D:

Short-term losses counterbalance expensive short-term gains. The balance at the end of Section I of Schedule D is the net short-term capital gain or loss. If there were no gains, then the net would equal a total loss.

Long-term losses are applied to long-term gains. The result, at the end of Section II of Schedule D, is the net long-term capital gain or loss. If there is only a loss, the net is a negative number.

Combine the short-term and long-term results. At this point, a loss in one section can offset a gain in the other section. For example, if there is a net short-term loss of $2,000 and a net long-term gain of $3,200, then taxes are paid on only $1,200.