What Is a Capital Loss Carryover? Rules, Examples and Definition

You may be familiar with the tax implications of capital gains, but what about capital loss? A capital loss refers to the money that your investments lose. You can write off your capital losses from your taxes year after year by using a capital loss carryover. This way, you only use the portion of losses you incur each year that helps you with your taxes.

Consider working with a financial advisor for tax-planning strategies for your specific situation.

What Is Capital Loss Carryover?

Capital loss carryover is the ability to use the capital loss tax deduction over multiple years if the loss is large enough.

This means you can use the capital loss to offset taxable income. The IRS caps your claim of excess loss at the lesser of $3,000 or your total net loss ($1,500 if you are married and filing separately).¹

Capital loss carryover comes in when your total exceeds that $3,000, letting you pass it on to future years’ taxes. There’s no limit to the amount you can carry over. You simply carry over the capital loss until complete.

IRS Topic No. 409 lays out what you need to know about capital loss carryover. It also includes links to worksheets you can use to determine the amount you can carry forward.

How to Deduct Capital Losses on Your Taxes

There are two main ways to write off capital losses from your taxes.

1. Deduct From Capital Gains

When you pay taxes, you calculate both your long- and your short-term capital gains taxes.

Long-term capital gains are all the profits from selling assets held for more than one year. They carry the lower capital gains tax rate.
Short-term capital gains are all the profits from selling assets you held for less than one year.

These are subject to ordinary income tax.

Then, you calculate your capital losses, in the same way, determining both long-term and short-term losses on the same basis.

Your capital losses offset same-category capital gains first. This means that long-term losses first offset long-term gains and short-term losses first offset short-term gains. Once your losses exceed your gains, you can carry that category’s losses over to the other.

For example, say you had the following trade profile in a year:

Long-term gains: $1,000
Long-term losses: $500
Short-term gains: $250
Short-term losses: $400

First, you deduct your long-term losses from your long-term gains, resulting in taxable long-term capital gains of $500 for the year ($1,000 – $500).

The next thing to do is to deduct your short-term losses from your short-term gains. Since your short-term losses are greater than your short-term gains, this leaves you with zero taxable short-term capital gains ($250 gains – $400 losses).

You now carry over excess losses from one category to the next. In this case, your short-term losses exceeded your short-term gains by $150. So you reduce your remaining long-term gains by that amount, leaving you with taxable long-term capital gains of $350 for the year ($500 long-term gains after losses – $150 excess short-term losses).

2. Deduct Excess Losses From Income

Capital losses can apply to ordinary income taxes - to a limited extent.

Say you have a very bad year with stock market losses. You sell stocks for a total gain of $10,000 but sell other stocks for a total loss of $15,000. You could deduct the first $10,000 of those losses from your capital gains, leaving you with no taxable capital gains for the year. This would leave you with an excess capital loss of $5,000.

You can claim $3,000 of those losses as deductions on your ordinary income taxes for the year. Then, the following year, you can claim the remaining $2,000, carrying forward the deduction on that year’s income taxes.

How a Capital Loss Carryover Can Reduce Future Taxes

A capital loss carryover is not limited to the tax year of the loss.

If your losses exceed what you can deduct in one year, the remaining amount generally carries forward. You can continue lowering taxable income or future capital gains until it is gone.

For example, assume you realize a $25,000 net capital loss and have no capital gains during the year. You could generally deduct up to $3,000 against ordinary income on that year’s tax return. The remaining $22,000 would carry forward to the next tax year.

Now assume that, two years later, you sell investments that produce a $15,000 capital gain. Instead of paying tax on the full gain, your remaining carryover could generally offset the entire $15,000 gain, leaving $7,000 in unused losses.

If you have no additional capital gains that year, you could generally deduct up to $3,000 against ordinary income. You can then carry the remaining $4,000 forward into the following tax year.

This is why tracking unused capital losses can be valuable. A loss realized today may continue reducing taxes for years, particularly if you later sell investments that have appreciated in value.

Knowing how much carryover remains can also help you estimate the tax impact of future investment sales before deciding when to realize gains.

What Is Tax Loss Harvesting?

Tax loss harvesting is a strategy that offsets capital gains with capital losses.

If an investor expects a windfall from the sale of one asset, they’ll also sell an underperforming asset at a loss to get the capital loss tax deduction. The investor is communicating to the IRS that, yes, they had a large gain, but they also had losses, so they should pay less in taxes.

The process of tax loss harvesting begins with identifying underperforming assets within an investment portfolio. Once you identify these assets, you sell them to realize a capital loss. You can then use this loss to offset capital gains from other investments, effectively reducing the taxable income.

If the losses exceed the gains, you can deduct up to $3,000 against ordinary income each year. Any remaining losses carry forward to future tax years.

Typically, investors who use tax-loss harvesting wait until the end of the year to confirm potential losses. After selling assets at a loss, they’ll buy up similar assets to remain invested in that space and maintain asset allocation.

Just keep in mind the wash-sale rule, so you don’t get in trouble with the IRS.

What Is the Wash Sale Rule?

The wash sale rule is a provision by the IRS to discourage investors from unfairly claiming tax breaks.

It prevents investors from selling an asset at a loss and then buying it again. The wash sale rule requires a minimum of 30 days to pass before or after a sale before repurchasing the assets sold at a loss.

The rule also prevents you from purchasing “substantially identical” assets in less than 30 days.² Unfortunately, the IRS does not define this concretely.

On Page 56 of Publication 550, they say, “In determining whether stock or securities are substantially identical, you must consider all the facts and circumstances in your particular case.” It’s safe to say that the same stock from the same company is substantially identical.

However, it’s a lot more complicated if you’re talking about buying and selling mutual funds. Here, it depends on the manager, the fund’s securities and the index they follow.

One way investors get around the wash sale rule is to trade stock for an ETF. For example, if you sell Meta stock at a loss to take advantage of the capital loss carryover, you can then buy a tech ETF that contains Meta. Because they’re not the same type of security, you won’t commit a wash sale, and you can still keep your assets in the tech sector.

Bottom Line

The capital loss carryover is a great resource you can use. It allows you to deduct up to $3,000 in capital losses each year, until the total capital loss is complete. You can use it as a tool to offset capital gains you receive. If you want to be strategic, you can also employ tax loss harvesting to make the most of the tax break. For help finding the right tax strategy, consider consulting a qualified financial advisor who can help decide what to do with your money.

Tips for Investing

You’re likely to incur losses at some point while investing, and when you do, it’s important that you make the most of them. A financial advisor can help you manage your investments or to create a long-term investment plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goalss, get started now.
Having the right balance of assets is essential to have a diverse and secure portfolio. SmartAsset’s Asset Allocation Calculator can help you determine where you should put your money depending on your risk profile.