What Is a Capital Loss?
A capital loss occurs when you sell a capital asset for less than its original purchase price. Capital assets include items like stocks, bonds, real estate (investment properties), and other investment vehicles. For example, if you bought shares for $1,000 and sold them for $700, you have a capital loss of $300.
Why Capital Losses Matter
Investing involves risks, including the possibility of losing money. The Internal Revenue Service (IRS) allows taxpayers to use capital losses to offset capital gains so that investors are not taxed on money they did not actually earn. This tax treatment encourages fair reporting of investment returns.
How Capital Losses Work in Taxes
When you sell an asset, the difference between your sale price and your purchase price results in a capital gain or loss:
- Capital Gain: Sale price exceeds purchase price.
- Capital Loss: Sale price is less than purchase price.
You report these transactions on Schedule D (Form 1040), used for reporting capital gains and losses. Capital losses first offset capital gains from other sales in the same tax year. If your total capital losses exceed your gains, you can deduct up to $3,000 ($1,500 if married filing separately) against other income such as wages or salaries per year. Any unused losses can be carried forward indefinitely to future tax years.
More on reporting capital gains and losses can be found in our detailed guide on Schedule D (Form 1040) – Capital Gains and Losses.
Real-Life Example
Suppose you purchased 10 shares of stock for $50 each, totaling $500. If you sold these shares for $400, your capital loss would be $100. If you also realized $500 in capital gains from other sales, the $100 loss reduces your net capital gain to $400, lowering your taxable income.
Who Should Understand Capital Losses?
Investors, business owners, and anyone engaged in buying or selling assets should understand how capital losses affect taxes. This knowledge helps in tax planning and making informed investment decisions.
Strategies to Manage Capital Losses
- Tax-Loss Harvesting: This strategy involves selling investments at a loss near year-end to offset realized capital gains, potentially reducing your tax bill. Immediately repurchasing a similar, but not “substantially identical,” asset allows you to maintain your investment position while benefiting from the loss deduction. Learn more about this strategy in our Tax-Loss Harvesting article.
- Avoiding the Wash Sale Rule: The IRS disallows losses from sales if you buy the same or a “substantially identical” security within 30 days before or after the sale. This rule prevents artificial loss claims. For full details, see our Wash-Sale Rule guide.
- Carrying Forward Losses: If your capital losses exceed your gains and $3,000 deduction limit, you can carry forward the unused losses to future tax years, reducing taxable income in those years. More on this in our Capital Loss Carryover page.
Common Misunderstandings
- “Capital loss means I lost money.” True, but reporting these losses can reduce your overall tax burden.
- “I must use my loss all at once.” No, losses beyond the annual deduction limit can be carried forward.
- “Losses on personal items count.” Usually not; personal property losses typically aren’t deductible.
Frequently Asked Questions
Can I use capital losses against my regular income? Yes, up to $3,000 per year ($1,500 if married filing separately), with additional losses carried forward. IRS Publication 544 explains this.
What happens if I trigger a wash sale? The loss is disallowed and added to the cost basis of the new purchase, delaying your tax benefit.
Do capital losses apply to my personal residence? No, capital losses on your primary home are generally not deductible. Losses apply mainly to investment properties.
Glossary
- Capital Asset: Any property held for investment or personal use.
- Capital Gain: Profit from selling a capital asset.
- Capital Loss: Loss from selling a capital asset below purchase price.
- Tax-Loss Harvesting: Strategy to reduce taxes by realizing losses.
- Wash Sale: IRS rule disallowing losses from repurchasing similar securities within 30 days.
Authoritative External Resource
For comprehensive IRS rules on capital gains and losses, visit the IRS Topic No. 409 – Capital Gains and Losses.
This explanation aims to help you understand capital losses with accurate, up-to-date tax information as of 2025 and provide links to related FinHelp glossary terms for deeper learning.