Claiming Investment Losses on Your Taxes

As the end of the year draws near we unfortunately have to start thinking about the taxes we’ll owe, our tax returns will be due before we know it.

If you’re not aware of the possible investment tax deductions one that you should think about is investment loss – the losses that result from your investments can offset some of your income.

Offsetting Capital Gains

First of all, your investment losses should be used to offset your capital gains. You pay capital gains when you see a net profit with your investments. However, if you have investment losses in other areas, you can use them, dollar for dollar, to offset your gains.

So, if you sell an investment for a $5,000 gain, and you sell another investment and end up with a $6,000 loss, your losses completely offset your gains. You owe no capital gains tax on your increase! When figuring out whether you have a gain or a loss overall, make sure that you start off by pairing off long-term gains with long-term losses, and short-term gains with short-term losses.

This is important, since short-term gains are taxed differently than long-term gains. If you have a net loss over all, though, it makes the situation a little easier. Double check your work with the IRS or with a knowledgeable tax professional before filing your tax return.

Offsetting Other Income

In the example above, there are losses “left over” from offsetting capital gains. If you still have losses after offsetting your capital gains, you can use those, up to $3,000 a year, to offset other income. So that left over $1,000 becomes a tax deduction from your “regular” income.

But what if your net losses are much bigger? In some cases, you might find that you have $4,000 left over after offsetting your capital gains. Well, you can still only use $3,000 of your left over losses to reduce your income. However, you can carry forward losses indefinitely.

So, you can carry the remaining $1,000 to the next tax year, and use that to reduce some of your tax liability. When deciding what to sell, think into the future. While it’s a benefit that you can carry forward losses, you don’t want so many losses that you are constantly carrying them forward with no end in sight. Make sure you carefully consider your situation, and decide on a strategy that works best for you.

Selling Your Losing Investments

As you prepare to sell your losing investments and harvest the tax loss, it is important to make sure that you do it right. First of all, understand that you can’t use losses on paper. The sell transaction has to actually be complete before the end of the year if you want it offset your income.

Also, if you want to gain a tax advantage from selling your losing investment, you have to avoid violating the wash sale rule. The IRS wash sale rule is simply that you can’t buy back a “substantially identical” investment within 30 days of selling your investment.

It’s not illegal to buy back an investment within that time period, but it will prevent you from claiming your losses as a tax deduction. So, if you decide to sell, make sure you don’t re-purchase the investment within 30 days. Your losing investments can be turned to your advantage with the right strategy. Take a look at the options, and consider that you might be able to benefit by reducing your taxable income by harvesting investment losses.

Miranda writes about personal finance almost every day. An experienced freelance writer, she's covered your money online and in print from every angle and is always looking for new ones.

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