What is a capital loss carryover?
– A capital loss carryover is the unused portion of a net capital loss that you postpone claiming and apply against income in future tax years. When your investment losses exceed your gains in a tax year, U.S. tax law lets you deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately). Any remaining loss can be carried forward indefinitely until fully used.
Key definitions
– Capital gain or loss: Proceeds from the sale of an asset minus your adjusted basis in that asset. Adjusted basis is typically the purchase price plus allowable costs of acquiring or improving the asset.
– Short-term vs. long-term: Short-term gains/losses come from assets held one year or less and are taxed at ordinary-income rates. Long-term gains/losses come from assets held more than one year and receive preferential tax rates (0%, 15%, 20% and, for certain assets, 25% or 28%).
– Wash sale: A rule that disallows a loss on sale of a stock or security if you buy a “substantially identical” security within 30 days before or after the sale. The disallowed loss is added to the basis of the new position.
How the carryover works — step-by-step
1. Calculate each transaction’s gain or loss: Sale proceeds − adjusted basis = gain (or loss).
2. Separate results by holding period: net all short-term items and all long-term items.
3. Net long-term gains/losses against long-term items first; net short-term against short-term.
4. Combine nets: if the overall result is a net loss, up to $3,000 may be used to reduce ordinary income in that tax year ($1,500 if married filing separately).
5. Any remaining loss after the $3,000 deduction becomes a capital loss carryover to the next tax year.
6. Report transactions on IRS Form 8949 and carry totals to Schedule D; use IRS Publication 550 (Worksheet 4-1) to compute carryovers precisely.
7. Watch the wash sale rule: if a loss is disallowed due to a wash sale, you cannot claim that loss now — instead it is added to the basis of the replacement shares.
Important rules and exceptions
– Losses on personal-use property (for example, losses from selling a personal residence) generally are not deductible.
– Losses on certain related-party or corporate exchanges are disallowed.
– Long-term capital losses must be applied to long-term capital gains first before offsetting short-term gains.
– The carryover may be tracked year-to-year without a time limit until it is exhausted.
– For married taxpayers who previously filed a joint return and later file separately, rules limit who can claim the carryover; married filing separately limits the annual deduction to $1,500 (or the amount of the loss if less).
Worked numeric example
– You sell an investment for $6,000. Your adjusted basis in that investment was $11,000.
– Loss = 6,000 − 11,000 = −$5,000 (a $5,000 capital loss).
– In the same year you had $1,000 of capital gains from other sales.
– First offset gains: −$5,000 + $1,000 = −$4,000 net capital loss.
– Deduct up to $3,000 of that net loss against ordinary income this tax year.
– Deduction this year = $3,000; remaining loss to carry forward = $4,000 − $3,000 = $1,000.
– Next year you begin with a $1,000 capital loss carryover that you apply using the same ordering rules.
Short checklist for reporting and managing a carryover
– Gather records: trade confirmations, purchase dates, and costs (to compute adjusted basis).
– Compute gains/losses per transaction and categorize as short-term or long-term.
– Net long-term items together and short-term items together; then combine for overall net gain/loss.
– Apply loss ordering: long-term losses to long-term gains first, etc.
– Claim up to $3,000 (or $1,500 if married filing separately) against ordinary income if you have a net loss.
– Record any remaining loss as a carryover and retain a year-by-year worksheet (IRS Pub 550 Worksheet 4-1 is designed for this).
– File Form 8949 with your tax return, and carry totals to Schedule D.
– Avoid wash sales: do not buy substantially identical securities within 30 days before or after a loss sale if you want to keep the deduction.
– Consult a
professional (CPA, enrolled agent or tax attorney) if you’re unsure how the rules apply to your situation, especially if you have large carryovers, complex trades, or potential wash-sale issues.
Practical checklist for handling a capital loss carryover
– Reconcile trades: keep a full year-by-year trade ledger that shows dates, proceeds, cost basis and whether each gain/loss is short-term (held one year or less) or long-term (held more than one year).
– Net by holding period: compute net short-term and net long-term gain/loss separately, then combine to get the overall net result for the year.
– Apply the $3,000 rule: if your combined result is a net loss, use up to $3,000 ($1,500 if married filing separately) to offset ordinary income on Form 1040. Any remaining loss becomes the carryover.
– Record carryover amounts: keep an annual worksheet (IRS Publication 550 has Worksheet 4-1) that shows the amount of carryover broken into short-term and long-term portions for the next tax year.
– Report properly: file Form 8949 to report each sale (unless an exception applies) and carry totals to Schedule D to show the net and the carryover deduction.
– Watch wash sales: if you repurchase substantially identical securities within 30 days before or after a loss sale, the loss is disallowed for that tax year and instead is added to the cost basis of the replacement shares (see note below). Disallowed wash-sale amounts are not immediately deductible as a carryover.
– Keep documentation: retain broker statements, trade confirmations, cost-basis reports, and your carryover worksheet for at least three years (longer if audit risk or complex basis adjustments exist).
Worked numeric example (step-by-step)
Assumptions: In Tax Year 1 you have:
– Short-term losses: $8,000
– Long-term gains: $2,500
1) Net long-term: $2,500 gain (no long-term loss to offset).
2) Net short-term: $8,000 loss.
3) Combine: $8,000 short-term loss minus $2,500 long-term gain = $5,500 overall net capital loss (this is treated as a net loss; ordering rules net long-term and short-term as above).
4) Deduct against ordinary income: you may deduct $3,000 this year. Remaining carryover = $5,500 − $3,000 = $2,500.
5) Carryover characterization: Because the net loss arose after netting, the carryover retains the character by timing rules used on the worksheet — in practice, track both short-term and long-term components into the next year’s calculation per IRS guidance so you can apply carryovers correctly against future gains.
How carryovers are used in subsequent years
– In the next tax year, treat carryovers as if they were realized in that year for ordering purposes: apply carried long-term losses against current long-term gains first, and carried short-term losses against current short-term gains first; then net the results.
– If you still have a net loss after offsetting that year’s capital gains, again you may use up to $3,000 against ordinary income and carry forward the remainder.
– Carryovers continue indefinitely until exhausted; there is no special expiration for federal income tax purposes.
Notes on wash sales and disallowed losses
– A wash sale occurs when you sell a security at a loss and buy a “substantially identical” security within 30 calendar days before or after the sale date (31-day window including the sale day).
– If a loss is disallowed by the wash-sale rule, you cannot claim it in the year of the sale. Instead, the disallowed loss amount is added to the cost basis of the replacement shares. That adjustment defers the loss until you dispose of the replacement shares in a non-wash-sale transaction.
– Because the loss is deferred by basis adjustment, it will affect future gain/loss calculations rather than becoming an immediate carryover deduction.
State tax differences and other considerations
– State tax treatment of capital loss carryovers varies. Some states follow federal rules; others have differences in deductibility or limits. Check your state’s department of revenue guidance.
– Retirement accounts: losses inside tax-advantaged accounts (IRAs, 401(k)s) generally aren’t deductible or carried over; only taxable account losses create federal capital loss carryovers.
– Inherited property and basis step-up: when you inherit assets, basis rules differ and may eliminate the possibility of a loss at the time of sale; see IRS guidance on basis for inherited property.
Record-keeping template (minimal)
– Year, Short-term loss carryover start, Long-term loss carryover start, Current-year short-term gains/losses, Current-year long-term gains/losses, Offsets applied, Amount applied to ordinary income, Carryover to next year.
Keeping one line per year makes it straightforward to roll forward carryovers without re-computing every past transaction.
When to consult a professional
– You have large or multi-year carryovers.
– Your trades include wash-sale chains, options, or short sales.
– You changed filing status (e.g., married filing separately vs jointly).
– You need state-specific advice or have estate/transfer issues.
Relevant official references
– IRS Publication 550, Investment Income and Expenses: https://www.irs.gov/pub/irs-pdf/p550.pdf
–
– IRS Topic No. 409, “Capital Gains and Losses”: https://www.irs.gov/taxtopics/tc409
– Instructions for Schedule D (Form 1040), “Capital Gains and Losses”: https://www.irs.gov/forms-pubs/about-schedule-d-form-1040
– Instructions for Form 8949, “Sales and Other Dispositions of Capital Assets”: https://www.irs.gov/forms-pubs/about-form-8949
– IRS Publication 544, “Sales and Other Dispositions of Assets”: https://www.irs.gov/pub/irs-pdf/p544.pdf
Educational disclaimer: This information is educational and general in nature, not personalized tax or investment advice. For decisions affecting your taxes or portfolio, consult a qualified tax professional or financial advisor who can consider your full circumstances.