Tax Implications of a Short Term Loss

by David Rodeck

To encourage investing, the Internal Revenue Service allows a tax deduction for capital losses. While the tax deduction will not fully compensate you for the loss, it will at least reduce the impact of an unprofitable investment. Your capital loss can be used to reduce taxes on the gains from other investments. If your loss is large enough, it can reduce your income taxes as well.

Short-Term Loss

Whether an investment loss is considered short-term or long-term depends on how long you owned the asset. If you held the asset for less than one year, the loss is considered short-term. If you held the asset for over a year, the loss is considered long-term. The same timeline is used for capital gains. Short-term gains are taxed at a higher rate than long-term gains. Short-term gains are taxed at your income tax rate while long term-gains are taxed at the capital gains rate of 15 percent.

Capital Loss Deduction

Capital losses are primarily used to reduce your capital gains taxes from other asset sales. Short-term losses are used to reduce your short-term capital gains. To calculate your net short-term gains, subtract your short-term losses from your short-term gains. If your short-term losses are greater than your short-term gains, you can subtract the remaining short-term losses from your long-term capital gains. You must use your short-term loss to reduce all possible capital gains.

Income Deduction

If your total losses for the year exceed your total capital gains, a portion of the remaining losses can be used to reduce your income tax liability. Excess losses can reduce your total income by up to $3,000 a year. If you are married filing separately, only $1,500 of the excess loss can be applied against your income. Any remaining loss over these limits cannot be deducted from your taxes this year.

Carryover Losses

If you cannot use all of a capital loss tax deduction in the year of the loss, the deduction is not lost. You are allowed to carry over unused capital losses to future tax returns. Your carried-forward loss will use the same tax procedure as a regular loss. It must first be used to reduce capital gain taxes with the remainder being used to reduce income taxes. Excess losses can be carried forward indefinitely until they have been completely deducted from your taxes.

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