How to Deduct Stock Losses From Your Tax Bill

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How to Deduct Stock Losses From Your Tax Bill

In a perfect world, you would never have any stock market losses. All your investmentswould be hugely profitable, and you would never be down even $1.

Unfortunately, this is not always the case for anybody, not even Warren Buffett. However, one reassuring point to remember anytime you suffer a loss is that losses may be used to decrease your total income tax burden. To get the most tax advantage, you must deduct them in the most tax-efficient manner feasible.

Key Takeaways

  • Capital losses from stocks may be utilized to lower your tax burden.
  • During a taxable year, you may utilize capital losses to balance capital gains, enabling you to deduct some income from your tax return.
  • If you don’t have any capital gains to offset the capital loss, you may use it to offset regular income up to $3,000 each year.
  • Fill out Form 8949 and Schedule D for your tax return to deduct your stock market losses.
  • If you possess stock that has become worthless as a result of the company’s bankruptcy and liquidation, you may declare a complete capital loss on the shares.

Understanding Stock Losses

Losses in the stock market are capital losses. They are also known as capital gains losses, which may be a little perplexing. Profits from the stock market, on the other hand, are capital gains.

The only capital gains or losses that may affect your income tax bill, according to US tax law, are “realized” capital gains or losses. When you sell anything, it gets “realized.” As a result, a stock loss becomes a recognized capital loss only when you sell your shares. If you keep the losing stock into the next tax year, that is, after December 31, it cannot be utilized to produce a tax deduction for the previous year.

Although the sale of any asset might result in a capital gain or loss, realized capital losses are only utilized to decrease your tax burden if the item sold was held for investment reasons.

This definition includes stocks, but not all assets. For example, selling a coin collection for less than you purchased for it does not result in a deductible capital loss. (This is infuriating because any profit made through the sale of the collection is taxable income.)

Determining Capital Losses

Capital losses, like capital gains, are separated into two categories: short-term and long-term. Short-term losses occur when a stock is sold after less than a year of ownership. Long-term losses occur when a stock is held for a year or longer. This is a crucial difference since short-term and long-term losses and earnings are regarded differently.

To determine your capital loss for income tax purposes, multiply the number of shares sold by the per-share adjusted cost basis, then subtract the total selling price. Your stock shares’ cost basis price, which refers to the fact that it serves as the foundation for calculating any later profits or losses, is the sum of the purchase price plus any expenses, such as brokerage fees or commissions.

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If there was a stock split while you held the shares, the cost basis price must be changed. In such situation, the cost basis must be adjusted to reflect the extent of the split. A 2-to-1 stock split, for example, involves a 50% reduction in the cost basis for each share.

Deducting Capital Losses

“Capital losses (stock losses) may be used to offset capital gains during a taxable year,” states CFP®, AIF®, CLU®. Simone Zajac Wealth Management Group’s Daniel Zajac. Zajac continues:

By doing so, you may be able to remove some income from your tax return.If you don’t have capital gains to offset the capital loss, you can use a capital loss as an offset to ordinary income, up to $3,000 per year. (If you have more than $3,000, it will be carried forward to future tax years.)

Fill out Form 8949 and Schedule D for your tax return to deduct your stock market losses. (Schedule D is a simple form that will show you how much money you’ll save.) More information is available from the IRS in Publication 544). On Part I of Form 8949, short-term capital losses are offset against any short-term capital profits to determine the net short-term capital gain or loss.

If you have no short-term capital profits or losses throughout the year, the net is a negative amount equal to the sum of your short-term capital losses.

Part II of Form 8949 calculates your net long-term capital gain or loss by deducting any long-term capital losses from any long-term capital gains. The next step is to compute the total net capital gain or loss by adding the short-term capital gain or loss and the long-term capital gain or loss. On the Schedule D form, that figure is recorded. For example, if you have a net short-term capital loss of $2,000 and a net long-term capital gain of $3,000, you only owe taxes on the net $1,000 capital gain.

If the total net figure of short- and long-term capital gains and losses is a negative number, indicating a total capital loss, that loss may be deducted from other reported taxable income up to the maximum amount permitted by the Internal Revenue Service (IRS).

As previously stated, the maximum amount that may be deducted from your total income for tax year 2021 is $3,000 for someone filing as single or married, filing jointly.

The maximum deduction for a married couple filing separately is $1,500. If your net capital gains loss exceeds the limit, you may carry it forward to the next tax year. This is referred to as the “marriage penalty.” The amount of loss that was not deducted in the previous year that exceeds the maximum may be used against capital gains and taxable income in the following year.

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The balance of a substantial loss, say $20,000, might be carried over to future tax years and applied up to the maximum deductible amount each year until the complete loss is applied.

It is essential to maintain track of all sales. That manner, if you continue to deduct your capital loss for several years, you may demonstrate to the IRS that you did, in fact, have a loss much above the $3,000 level.

A Special Case: Bankrupt Companies

If you possess stock that has become worthless as a result of the company’s bankruptcy and liquidation, you may declare a complete capital loss on the shares. The IRS, on the other hand, wants to know how the stock’s value was judged to be zero or worthless. As a result, you should preserve some type of record of the stock’s zero value, as well as evidence of when it became worthless.

Essentially, any proof demonstrating the stock’s inability to provide a positive return is acceptable. Acceptable proof includes canceled stock certificates or evidence that the stock is no longer traded elsewhere. Some insolvent corporations enable you to repurchase their shares for a cent. This demonstrates that you have no additional stock in the firm and records what is effectively a complete loss.

Considerations in Deducting Stock Losses

To maximize your tax advantage, always try to accept your tax-deductible stock losses in the most tax-efficient method feasible. Consider the tax consequences of different losses you may be able to deduct. As with other deductions, it’s important to be aware of any rules or regulations that may exclude you from claiming the deduction, as well as any loopholes that may benefit you.

Because long-term capital losses are taxed at the same lower rate as long-term capital profits, accepting short-term capital losses results in a bigger net deduction. As a result, if you have two stock investments with about equal losses, one for many years and one for less than a year, you may opt to absorb both losses.

However, if you only want to realize one of the losses, selling the stock you’ve held for less than a year is preferable since the capital loss is calculated at the higher short-term capital gains tax rate.

It is normally preferable to incur any capital losses in the year in which you are taxed on short-term profits, or in a year in which you have no capital gains, since this lowers your overall regular income tax rate. Do not attempt to sell a stock at the end of the year for a tax benefit and then purchase it back the next year.

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If you sell a stock and then buy it back within 30 days, the IRS deems this a “wash sale,” and the transaction is not taxed. If you sold the shares to a relative, you cannot deduct the capital loss. This is done to prevent families from claiming the capital loss deduction.

Your tax bracket is important. For tax year 2018, if you are in the 10 or 12% tax band, you are not required to pay any capital gains taxes. As a result, you don’t have to worry about balancing any such profits with capital losses. If you are in that tax band and have stock losses to deduct, they will be deducted from your regular income.

The Bottom Line

As long as you must pay taxes on your stock market winnings, it is critical to understand how to benefit from your stock market losses as well. Losses might be advantageous if you owe taxes on any capital gains, and you can carry the loss forward to utilize in future years.

The most efficient approach to utilize capital losses is to subtract them from your taxable income. You almost definitely pay a higher tax rate on regular income than on capital gains, so deducting those losses makes more sense.

It’s also advantageous to deduct them from short-term capital gains, which are taxed at a significantly higher rate than long-term capital gains. Also, before you may utilize your short-term capital loss to balance a long-term capital gain, you must first offset a short-term capital gain.

Regardless of the tax ramifications, the bottom line on whether you should sell a losing stock investment and so realize the loss should be established by whether you anticipate the stock to return to profitability after thorough research. If you still feel the stock will eventually pay off, it is generally not a good idea to sell it solely to gain a tax break.

However, if you discover that your initial appraisal of the stock was simply incorrect and that you do not anticipate it to ever become a lucrative investment, there is no need to continue holding when you may utilize the loss to gain a tax advantage.

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