$3,000 Capital Loss Deduction

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At the end of last year I wrote a few articles about stocks and taxes, the most important of which was the concept of deducting capital losses against capital gains. One sentence in the article talked about when you have an excess of capital losses, an idea I wanted to expand upon given the recent blood letting in the capital markets. Given the combination of a slowing economy and some unrealized losses sitting on the books, consumers might want to realize the loss and take the $3,000 deduction from their regular income.

For example, if I bought $10,000 of stock in Company ABC and that stock was now worth $7,000 – I would be realizing a $3,000 loss. I record the loss on my tax return (Form 1040, Schedule D) and then transfer it to my regular form to deduct from my income. That limit is reduced to $1,500 for those married filing separately. If your losses exceed $3,000, then you can keep carrying that over year to year indefinitely.

Why would you want to do this? Your tax refund will be larger because you’ve reduced your income by $3,000. If you’re in the 25% tax bracket, your tax return would increase by $750. You’ve already lost the money, you simply haven’t realized it yet. 🙂

Why WOULDN’T you want to do this? The wash rule states that you can’t claim a capital loss if you buy back into the investment within 30 days. You can buy back in after the 31st day but anytime before that and you’ve realized a loss without the tax deduction.

It’s neither a smart move or a dumb move, just a move that is made smart or dumb based on your situation.

{ 7 comments, please add your thoughts now! }

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7 Responses to “$3,000 Capital Loss Deduction”

  1. Miss M says:

    I haven’t done this before but I’m certainly thinking about it this year, I’ve generally stuck with buy and hold. I’ve got an investment or two that in hindsight, don’t seem like such a good idea. If I’m not sure it’s a good investment, why hold on to it… I’m waiting a little longer before I do it, want to look at my expected taxes this year first.

  2. A Non says:

    I think you mean “tax refund” not “tax return”

    Another important aspect is that the $3,000 is taken off your AGI (bottom of the first page of you 1040 tax form) – this amount affects many other taxes – earned income, credit, liability for alternative minimum tax (AMT), phaseout of personal exemption, phaseout of itemized deductions and possiblly other items.

    However, selling at a loss and buying another similar investment reduces your cost basis compared to the original investment. For example, if you took the $7,000 sale proceeds in your example and reinvested in a similar investment that subsequently increased in value to $10,000 then you would be liable for tax on the $3,000 gain, but this would be at the lower tax rate levied on capital gains.

    In summary, selling at a loss accomplishes two things: provides an immediate tax reduction in exchange for a subsequent tax; and converts a taxable gain at a lower rate (cap gains) into a tax loss at a higher rate (earned income tax rate)

  3. Steve says:

    What some people don’t realize is that if you do buy back into the same stock within the 30 days and violate the wash rule, in the IRS’s eyes your new cost basis includes the disallowed loss. So you don’t completely lose the ability to deduct the loss, you just delay it until you sell the new shares.

    Ex: If you buy at $1000, sell at $800. The next day you decide that was a mistake. You buy back in at $800. You cannot deduct the $200 this year, but when you eventually sell the shares, you will essentially deduct the loss from the first sale since your cost basis is $800 + $200 disallowed loss.

  4. Chris says:

    Investment/Tax pros like to call this strategy “harvesting your losses“. You sell your beaten up fund to get your tax loss, buy another fund that holds similar stocks to stay in the sector for 31 days (if you prefer), & then sell the subustitued fund after 30 days & buy into your old fund. You get the tax loss, get to stay in the same sector for the month period, & then buy your old fund again at a lower pricer. Esy as pie!


  5. Steve says:

    Selling to take advantage of the tax deduction is a good way to recover some money out of a bad situation. A lot people don’t sell hoping to see a stock recover in the short term.

  6. Rick says:

    I bought in 2010 @ $1761.50 and sold this stock in 2012 @ $38.51. Not 100% sure but I can claim the difference at a capitol loss, correct? These figures are with the commission/fees..

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