Losing money can be inevitable even if you haven’t been investing for long. A string of unfruitful investments in quick succession can lead to short-term capital losses, which accrue as you sell assets that have plunged in value. Short-term capital losses refer to investments you held and sold under twelve months. You can use them to offset future short-term capital gains. Consider working with a financial advisor if you’re wondering how a short-term capital loss can help your finances.
What Are Short-Term Capital Losses?
Short-term capital losses occur when you sell an asset for less than you purchased it for within a year of purchase. For example, say you purchase stock for $400. Unfortunately, the stock’s value decreases and six months later you decide to rid yourself of the asset. The share is worth $250, meaning your short-term loss is $150.
Remember, the fact that your stock dropped in value doesn’t create a loss. A capital loss or gain on investment only occurs when you sell the asset, otherwise known as realizing. Hanging onto an asset keeps you from realizing its loss. As a result, keeping an asset whose value has plummeted means not realizing the loss and, therefore, not incurring a short-term capital loss.
How Are Short-Term Capital Losses Determined?
You can determine short-term capital losses by subtracting your losses from profits from short-term assets for this year. For example, say you sold two short-term assets over the last year. The first asset netted you a profit of $1,500. Then, you sold the second asset for less than you bought it for and lost $2,000. So, your short-term capital loss is $500.
However, short-term capital losses can have tax implications for multiple years. For example, if you accumulate $5,000 of losses in one year, you can claim a maximum of $3,000 in the current year’s tax return and the remaining $2,000 in the next year’s tax return. In addition, your capital losses can offset all types of income, including wages.
Short-Term Capital Losses vs. Long-Term Capital Losses
Time is the difference between short-term and long-term capital losses. Assets you hold for a year or less before selling are short-term, while assets you hold for more than a year create long-term losses.
In addition, these types of capital losses and gains have different tax rates. Specifically, the government taxes short-term capital gains as regular income. Therefore, you’ll pay taxes at the same rate as your salary, tips, commissions, interest and business earnings. On the other hand, long-term capital gains incur capital gains tax rates between 0% and 28%. The exact rate depends on your income level and the asset you sold.
How to Deduct Short-Term Capital Losses on Your Tax Return
You can deduct short-term capital losses on your tax return by following these steps:
- Collect relevant tax forms stating gains and losses: Before filing taxes, you should receive Form 1099-B from stockbrokers you use and Form 1099-S concerning real estate transactions.
- Sort your losses:. Form 8949 allows you to separate your investment activity into short-term and long-term gains and losses. Remember, assets held for a year or less before selling are short-term.
- Calculate losses on Schedule D on Form 1040: For example, if you have $500 of short-term losses and $100 of short-term gains, your total short-term loss is $400.
Remember, when you identify your short-term capital loss, you can combine it with long-term capital gains and losses (if you have either) to generate your net gains or loss. This figure influences how much you owe in taxes for your investments and other income.
How to Use Short-term Capital Losses to Offset Gains or Income
After using short-term loss to calculate net capital loss, you can apply it to investment gains and other income to decrease your tax burden. For example, if you use Schedule D and calculate a loss of $5,000, federal law allows you to apply $3,000 of it to decrease income taxes. Plus, you can similarly apply the remaining $2,000 of losses on next year’s taxes.
Deduction and Carryover of Loss Limits
Short-term and long-term capital losses combine when you file taxes to create a net capital loss. Net capital loss has a limited tax implication: you can claim up to $3,000 (or $1,500 if married filing separately) of capital losses per year on your tax return to offset income from other sources.
If you have capital losses over the $3,000 limit, you can carry them into the next tax year and claim another $3,000. For example, if you have $10,000 of net capital losses, you can claim $3,000 per year for three years and $1,000 for the last year. Tax law allows you to carry over capital losses into future years without a limit on the value of losses or the number of years.
The Bottom Line
Short-term capital losses occur when you sell assets after holding them for a year or less and fail to produce income. When you file taxes, these losses combine with other losses and gains made on investments throughout the year to calculate your net capital loss. If you incur a net capital loss, you can deduct $3,000 of losses from your income taxes. As a result, claiming short-term capital losses on your tax return is crucial, as it will lower your tax burden.
Tips for Short-Term Capital Losses
- Trading assets can complicate your tax returns and it’s not always clear which forms to fill out or which numbers to use. If you’d rather leave that to a professional, a financial advisor can help. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Use our capital gains tax calculator to see how much you owe for your investments this year.
- Capital gains taxes can mitigate productive investments. As a result, it’s critical to make the most of your money by strategically avoiding capital gains taxes.
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