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Updated for 2011

Capital Gains and Losses: Capital Losses

Capital Losses versus Ordinary Losses

For tax purposes, the terms capital loss and ordinary loss have specific meanings. A different tax treatment applies to each type of loss.

An ordinary loss is 100% deductible in the year incurred. The deduction for a net capital loss is limited to $3,000 per year.

Capital losses:

A capital loss results when you dispose of a capital asset (e.g., stocks and bonds) for less than your cost.

Capital loss deduction limitation:

Each tax year, capital losses must first be deducted from capital gains (if any).

Then, if net capital losses exceed net capital gains you may deduct up to $3,000 of the excess loss from other income reported on Form 1040 (e.g., wages you or your spouse earned, interest, dividends, etc.).

If net capital losses exceed net capital gains by more than $3,000, the excess over $3,000 must be carried over to the following tax year.

A capital loss that is carried over to the next tax year is included in the calculation of net capital gains and losses of that year.

The same procedure is followed each year for capital losses.

Example:

Deducting a capital loss:

You paid $12 a share for 1,000 shares of XYZ stock ($12,000).
You sell the 1,000 shares of XYZ for $7 a share ($7,000) incurring a $5,000 loss ($12,000 minus $7,000).
You sold 100 shares of ABC stock and realized a capital gain of $1,000.
The capital loss and capital gain are both short term (you held all your stock only six months during 2011)
You realized a net profit from your consulting business of $10,000.

You have a net capital loss of $4,000 ($5,000 loss minus $1,000 gain).

Reporting the 2011 capital loss and gain :

You enter your short-term capital gain and capital loss in Part I of Schedule D.
The capital loss exceeds the capital gain by $4,000 ($5,000 minus $1,000).
You enter only $3,000 of the loss on Form 1040.
On Form 1040 you subtract the $3,000 loss from the $10,000 net profit from your consulting business.
The excess loss of $1,000 ($4,000 minus $3,000) must be carried over to the following year, 2012.

Ordinary losses:

Ordinary losses are not subject to the capital loss rules.

Ordinary losses are fully (100%) deductible in the year incurred against other income reported on Form 1040 (e.g., wages you or your spouse earned, interest, dividends, etc.).

For example, a net business loss incurred by a sole proprietorship (Schedule C or F) is an ordinary loss and is fully deductible from any other income reported on Form 1040.

You simply enter a Schedule C net business loss on Form 1040 and subtract it from other income.

Example:

Deducting an ordinary loss.

You incurred a $10,000 loss in your part-time consulting business (reported on Schedule C).
You earned $30,000 from your regular job.

You may deduct the full $10,000 from your $30,000 salary, reducing it to $20,000.

You enter the business loss of $10,000 on Form 1040 and subtract it from your salary, which is reported on Line 7.

Your tax savings:

If you were in the 25% tax bracket, the $10,000 loss deduction would slash your taxes by $2,500 (25% x $10,000).

Capital Losses: Nine Rules for Capital Losses

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Capital Gains and Losses: Capital Losses

Capital Losses versus Ordinary Losses

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