Nine Rules for Capital Losses

1. Annual deduction limit

The deduction limit for a net capital loss in any one year is $3,000.

2. Excess loss over $3,000

If a capital loss exceeds $3,000 in any tax year, the excess over $3,000 must be carried over to the next tax year.

3. Carrying over a capital loss

Treat the loss as if it was incurred in the carryover year. Include the carryover loss in the computation of net capital gains and losses incurred in that tax year.

A long-term capital loss and short-term capital loss retain their original character as long-term or short-term in the carryover year.

4. Where to deduct a capital loss

A capital loss is deducted on Form 1040. It serves to reduce other income reported on Form 1040.

5. Form 8949 and Schedule D

Beginning in 2011, Form 8949 was introduced. Consequently, instead of reporting capital gains and losses directly on Schedule D, as was the case prior to 2011, capital asset transactions must now be reported on Form 8949 and the results reported on Form 8949 are carried to Schedule D.

6. How to deduct capital losses

Begin by deducting net capital losses from capital gains in the following order:

First, reduce any gains subject to the 28% rate (e.g., gains on collectibles and qualified small business stock).

Next, use any remaining loss to reduce gains subject to the 25% rate (e.g., unrecaptured Section 1250 gains).

Finally, use any remaining loss to reduce gains subject to the lowest capital gains rates..

If any net capital loss still remains after the above procedure is completed, deduct up to $3,000 from other income reported on Form 1040, line 13.

If any excess loss over $3,000 remains, carry it over to the next tax year. The loss retains its original character as short-term or long-term.

7. Married couples

Married couples may only deduct up to $3,000 of net capital losses on a joint return or $1,500 each if filing separate returns.

Neither spouse may deduct the other's loss on his separate return.

8. Related taxpayers

A loss on a sale to a related taxpayer may not be deducted.

9. Deceased taxpayer

If a taxpayer dies and has a capital loss on his own property, the loss may be deducted up to $3,000 on his final return.

If the loss exceeds the $3,000 limit, the excess over $3,000 is lost forever (it may not be deducted by the estate or carried over by a surviving spouse).

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