A short-term loss is realized when an asset is sold at a loss that's only been held for less than one year. A short-term unrealized loss describes a position that is currently held at a net loss to the purchase price but has not been close out (inside of the one-year threshold). Net short-term losses are limited to a maximum deduction of $3,000 per year, which can be used against earned or other ordinary income.

Breaking Down Short-Term Loss

Short-term losses are determined by calculating all short-term gains and losses declared on Part II of the IRS Schedule D form. If the net figure is a loss, then any amount above $3,000 -- or $1,500 for those married filing separately -- must be deferred until the following year. For example, if a taxpayer has a net short-term capital loss of $10,000, then he can declare a $3,000 loss each year for three years, deducting the final $1,000 in the fourth year following the sale of the assets.

Short-term losses play an essential role in calculating tax liability. Losses on an investment are first used to offset capital gains of the same type. Thus, short-term losses are first deducted against short-term capital gains, and long-term losses are deducted from long-term gains. Net losses of either type can then be deducted from the other kind of gain.

Example of Short-Term Loss

For example, if you have $1,000 of short-term loss and only $500 of short-term gain, the net $500 short-term loss can be deducted against your net long-term gain, should you have one. If you have an overall net capital loss for the year, you can deduct up to $3,000 of that loss against other kinds of income, including your salary and interest income, for example. Investors can enjoy the benefit of any excess net capital loss being carried over to subsequent years, to be deducted from capital gains and against up to $3,000 of other kinds of income. As noted above, when using a 'married filing separate' filing status, however, the annual net capital loss deduction limit is only $1,500.