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MY CLIENT ROSTER includes investors who have suffered enormous losses on their stock market investments. To ease their discomfort, I steer the conversation to what they’re entitled to deduct for capital losses. While the IRS imposes strict limits on simply writing off such losses, I assure my clients that there are perfectly legal, IRS-blessed opportunities to sidestep these restrictions.
The big hurdle is a deduction cap of $3,000 for both married couples and single filers. The cap drops to $1,500 for married persons who file separately from their spouses. This is the amount of capital losses that you can use to reduce your ordinary income—a wide-ranging category that includes income received from sources like salaries, pensions and interest. These dollar limits haven’t increased since they went on the books in 1978, when Jimmy Carter was in the White House.
In my experience, many individuals focus only on the $3,000 ceiling—and are completely unaware that the tax code allows taxpayers to use their investment losses to offset capital gains on other kinds of assets.
For instance, taxpayers can offset losses realized on stock and bond sales in their taxable account against gains on sales of capital assets other than stocks and bonds. This opportunity opens up many possibilities: You might offset your stock market losses against gains on sales of collectibles, personal residences and vacation homes.
A client I’ll call Louise met with me to discuss the pending sale of her personal residence. She expects her profit to considerably exceed the applicable exclusion amount for sellers (up to $500,000 for married couples filing jointly, and up to $250,000 for single individuals and married couples filing separate returns). My no-brainer advice: She should realize existing paper losses on some of her stocks and offset those losses against the taxable part of the gain from her home sale.
How much is Louise allowed to deduct and when? It depends. The law lets Louise use capital losses to erase taxes on capital gains realized during the same tax year, up to the total amount of gains. The IRS couldn’t care less whether her gains and losses are a mixture of short- and long-term.
Suppose Louise actively trades stocks and makes many bad bets. Her net capital losses greatly exceed her capital gains. The good news: She won’t have to pay taxes on any of her realized capital gains. But how much additional tax relief can she count on for 2017? Not all that much. She gets to offset net losses against no more than $3,000 of ordinary income.
How quickly will Louise be able to apply her unused losses, above that $3,000, to 2018 and succeeding years? Consider an example: For 2017, active trader Louise has losses of $260,000 and gains of $240,000, with $40,000 from selling some winning stocks and $200,000 from the gain on the sale of her home, over and above the exclusion amount. Thanks to her losses, Louise saves $6,000 in taxes on her winning stocks and $30,000 in taxes on her home sale, assuming she would have paid capital gains taxes at 15%.
After offsetting those gains, Louise is left with a net loss of $20,000 in 2017. On Form 1040’s Schedule D, she subtracts $3,000 of the loss from ordinary income and is allowed to carry forward $17,000 from 2017 into 2018. On 2018’s Schedule D, she uses the remaining loss (unless it’s offset by realized capital gains in 2018) to trim ordinary income by no more than $3,000 and then carries forward $14,000 from 2018 to 2019, and so on indefinitely.
Julian Block wrote and practiced law in Larchmont, New York, and was formerly with the IRS as a special agent (criminal investigator). He died in 2023. Check out the articles that Julian wrote for HumbleDollar.
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