Using Prior Year Capital Losses to Reduce Your Taxable Income This Year

If you lost money on the sale of investments or other capital assets in a prior year, you may be able to apply that loss against gains you have this year. You would be able to do this if you had a net capital loss in a prior year and could not claim the entire loss due to the tax restrictions on the amount of capital loss you can claim in one year.

According to the IRS, if your capital losses exceed your capital gains you have a net capital loss. You can use up to $3,000 of that loss to offset other taxable income, such as salaries and wages, interest and dividends. If the capital loss is more than $3,000, you can carry over the excess and apply it against capital gains the next year. If there is still a carryover loss left after offsetting your capital gains you can apply up to $3,000 against other taxable income. You can continue doing this year after year until the capital loss is completely used up. If you are married filing separately, the limit is $1,500.

For example, if you had a net capital loss of $12,000 in 2008, you could have used up to $3,000 to reduce other taxable income that year. That left you with a loss carryover balance of $9,000. If you had no capital gains in 2009, you could use $3,000 of the loss carryover to reduce other taxable income in 2009, leaving you with a loss carryover balance of $6,000. If you had capital gains of $2,000 in 2010 you could use the loss carryover to offset those gains and also apply $3,000 against other income. That would leave you with a loss carryover balance of $1,000 to use in 2011.

To figure the amount of the loss carryover each year you have to complete the Capital Loss Carryover Worksheet in the instructions for Schedule D. If you use tax software to prepare your return you may be prompted to enter the corresponding figures and the loss carryover will be calculated for you. The IRS points out that when you figure the capital loss carryover to the next year you have to take into account the current year's deduction, whether or not you claimed it and whether or not you filed a return. You cannot skip a year and use the loss carryover in a later year.

According to the IRS, capital loss carryovers remain short term or long term losses. If you carry over a long term capital loss it is used first to offset any long term capital gains in the current year. Any excess would then be used to offset short term capital gains in the current year.

If you previously filed separate returns and are now married filing a joint return, you and your spouse would combine your separate capital loss carryovers on your joint return. If you previously filed jointly and are now filing separately, only the spouse who actually had the loss can use the capital loss carryover.

A capital loss can be carried over indefinitely. But for a decedent, the carryover ends with the final return filed. And on that return the carryover loss can be used only up to the normal limit. For example, if the carryover loss was $4,000, only $3,000 could be applied against taxable income on that final return.

It is important to note that you do not have a loss for U.S. federal income tax purposes until you actually sell the investment or other asset. For example, a decrease in the value of your investment portfolio is an unrealized loss. You only have a loss for tax purposes when you actually sell the investments and have a realized loss.

Sources:

Instructions for Schedule D, IRS

Publication 550, Investment Income and Expenses, IRS