What Is a Capital Loss Carryover?

Capital loss carryover is the net amount of capital losses eligible to be carried forward into future tax years. Net capital losses (the amount that total capital losses exceed total capital gains) can only be deducted up to a maximum of $3,000 in a tax year. Net capital losses exceeding the $3,000 threshold may be carried forward to future tax years until exhausted. There is no limit to the number of years there might be a capital loss carryover.

Key Takeaways

  • Capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year.
  • Net capital losses in excess of $3,000 can be carried forward indefinitely until the amount is exhausted.
  • Due to the wash-sale IRS rule, investors need to be careful not to repurchase any stock sold for a loss within 30 days, or the capital loss does not qualify for the beneficial tax treatment.

Understanding Capital Loss Carryover

Capital loss tax provisions lessen the severity of the impact caused by investment losses. However, the provisions do not come without exceptions. Investors must be careful of wash sale provisions, which prohibit repurchasing an investment within 30 days of selling it for a loss. If this occurs, the capital loss cannot be applied toward tax calculations and is instead added to the cost basis of the new position, lessening the impact of future capital gains.

Tax-Loss Harvesting

Tax-loss harvesting provides a mean of improving the after-tax return on taxable investments. It is the practice of selling securities at a loss and using those losses to offset taxes from gains from other investments and income. Depending on how much loss is harvested, losses can be carried over to offset gains in future years. Tax-loss harvesting often occurs in December, with December 31 being the last day to realize a capital loss.

Taxable investment accounts identify realized gains generated for the year, so the investor seeks to find unrealized losses to offset those gains. Doing so allows the investor to avoid paying as much in capital gains tax. If the investor wants to repurchase the same investment, they must wait 31 days to avoid a wash sale.

For example, suppose a taxable account currently has $10,000 of realized gains that were incurred during the calendar year, yet, within its portfolio is ABC Corp stock with an unrealized loss of $9,000. The investor may decide to sell the stock prior to the end of the year in order to realize the loss. If the ABC Corp stock was sold on or prior to December 31, the investor would realize $1,000 ($10,000 gains - $9,000 ABC Corp loss) in capital gains. Abiding by the wash-sale rule, if the stock was sold on December 31, the investor would need to wait until January 31 to repurchase it.

Example of Capital Loss Carryover

Any excess capital losses can be used to offset future gains and ordinary income. Using the same example, if ABC Corp stock had a $20,000 loss instead of $9,000 loss, the investor would be able to carry over the difference to future tax years. The initial $10,000 of realized capital gain would be offset, and the investor would incur no capital gains tax for the year. In addition, $3,000 can be used to reduce ordinary income during the same calendar year.

After the $10,000 capital gain offset and the $3,000 ordinary income offset, the investor would have $7,000 of capital losses to carry forward into future years. Carrying losses forward is not restricted to the following tax year. Losses can be carried forward into future years until exhausted.