Capital loss
Definition
Capital Loss
A capital loss occurs when you sell a capital asset, such as stocks, bonds, real estate, or crypto, for less than your cost basis. It mirrors capital gains and lets you offset gains and, within limits, ordinary income under the U.S. tax code.
A capital loss is realized when a capital asset sells below its adjusted cost basis. Cost basis typically equals your purchase price plus commissions and acquisition costs. Capital assets include shares, bonds, mutual fund units, investment property, collectibles, and digital assets.
The IRS categorizes capital losses by holding period: short-term losses involve assets held one year or less; long-term losses involve assets held longer than one year. This distinction matters because short-term and long-term items net separately before crossing over, affecting tax outcomes (IRS Topic 409).
Paper value declines don’t count. A loss becomes deductible only through an actual sale, exchange, or similar disposition (NerdWallet: 10 Rules of Tax-Loss Harvesting). A stock dropping 40% creates an unrealized loss — trackable, but invisible to tax returns until sold.
How It Works
The process follows three steps. First, net short-term losses against short-term gains and long-term losses against long-term gains. Second, if one category shows a net loss, it offsets the other. Third, any remaining net capital loss can offset up to $3,000 of ordinary income annually — $1,500 if married filing separately — with unused amounts carrying forward indefinitely (IRS Publication 550).
Carryforward is the mechanism enabling capital-loss planning. A $20,000 net loss with no gains to absorb it reduces ordinary income by $3,000 yearly for subsequent years until exhausted, roughly six years in this scenario. The carryforward keeps its original short-term or long-term character across tax years.
The wash-sale rule is the primary trap. Selling a security at a loss while buying a “substantially identical” security within 30 days before or after triggers IRS disallowance, rolling the loss into replacement share basis (Fidelity: Wash-Sale Rules). The rule applies across accounts, including spouses’, and as of 2024 Treasury guidance treats most crypto trades outside the wash-sale net, though Congress may revise the carve-out.
Holding Period Comparison
| Holding Period | Tax Treatment | Offsets First | Annual Ordinary-Income Cap |
|---|---|---|---|
| Short-term (≤1 year) | Taxed as ordinary income when net gain | Short-term gains | $3,000 |
| Long-term (>1 year) | Taxed at 0%, 15%, or 20% when net gain | Long-term gains | $3,000 |
| Net capital loss | Offsets other bucket, then ordinary income | Either bucket | $3,000/year, indefinite carryforward |
Examples
In 2022, Meta Platforms shares slid from roughly $336 in January to about $120 by November. An investor who bought 500 shares at the January peak and sold at the November low locked in a short-term loss near $108,000, applicable against 2022 short-term gains, then long-term gains, then $3,000 against salary, with the remainder rolling to 2023.
Following the FTX collapse in November 2022, many U.S. taxpayers booked realized crypto losses by selling tokens on functioning exchanges before year-end. The IRS classifies most digital assets as property, so the losses netted against capital gains using the same Schedule D rules applied to shares.
Commercial real estate shows larger-scale application. A Manila-based investor who bought a Makati office floor for $5 million in 2018 and sold it for $3.8 million in 2024 recorded a $1.2 million long-term loss, useful against other property-sale gains but capped at $3,000 annually against ordinary income for individual filers.
Tax-loss harvesting is the deliberate approach. Vanguard’s 2024 research estimates that systematic harvesting can add roughly 0.47% to 1.27% in annual after-tax return, depending on tax bracket, portfolio turnover, and volatility (Vanguard Research, 2024).
Related Terms
- Capital gains: The counterpart, representing profit on an asset sale
- Bond: Fixed-income asset that can generate capital losses when sold below par
- Interest rate: Rising rates push bond prices down, creating paper losses
- Dividend: Income distributions taxed separately from capital gains and losses
- Asset allocation: Portfolio mix that determines how often losses occur
- Growth investing: Higher-volatility style that produces more harvestable losses
- Value investing: Contrarian approach that can hold positions through deep paper losses
FAQ
How much capital loss can I deduct in one year?
Net capital losses offset capital gains in full, then up to $3,000 of ordinary income yearly, or $1,500 if married filing separately. Anything left over carries forward indefinitely until used.
What is the difference between a realized and an unrealized capital loss?
A realized loss happens when you actually sell or dispose of the asset below cost. An unrealized loss exists only on paper, since the holding has declined in value but no sale has occurred, making the loss non-deductible.
Does the wash-sale rule apply to all assets?
It applies to stocks, bonds, mutual funds, ETFs, and options on those securities. As of 2024 IRS guidance, most cryptocurrencies sit outside the rule because they’re classified as property rather than securities, though pending legislation may close that gap.
Can a capital loss reduce my salary or wage income?
Yes, but only by up to $3,000 yearly after gains have been offset. The remainder carries forward to future years at the same $3,000 annual cap until the balance is gone.
Do capital losses expire if I do not use them?
No. Under current U.S. tax law, unused capital-loss carryforwards have no expiration date for individuals, though they end at the taxpayer’s death. Corporate carryforwards follow a different five-year rule.
How do I report a capital loss?
Individual U.S. taxpayers report sales on Form 8949 and summarize them on Schedule D of Form 1040. Brokers issue Form 1099-B with cost basis and proceeds for most covered securities, feeding directly into those forms.
Independent
