What is 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 (total capital losses minus total capital gains) can only be deducted up to a maximum of $3,000 in a tax year. Net capital losses exceeding this threshold may be carried forward to future years.
Understanding Capital Loss Carryover
Capital loss tax provisions lessen the severity of the impact investment and asset losses cause. 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 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 incurred for the year and find losses to offset those gains. Doing so allows the investor to avoid paying 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 Apple stock with an unrealized loss of $9,000. If the Apple stock was sold on or prior to December 31, the investor would realize $1,000 ($10,000 gains - $9,000 Apple 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.
Capital Loss Carryover Example
Any excess capital losses can be used to offset future gains and ordinary income. Using the same example, if Apple stock had a $20,000 loss instead of $9,000 loss, the investor would be able to carry over the difference. The initial $10,000 of realized capital gain would be offset, and the investor would incur no gains 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.