A capital loss is incurred when you sell an asset for less value than its purchase price. Capital losses are bad for your finances, but they can be good for your taxes. If you incur capital losses, you can use them to offset capital gains or even your regular income.
Short-Term and Long-Term Capital Losses
If you held the asset that you sold for one year or less, then your capital gain or loss is considered short-term. However, if you held the asset for more than one year before selling it, then your capital gain or loss is long term. You may calculate the time duration by subtracting the date of the purchase from the date of the sale of the asset.
A loss in the short-term can offset a gain in the long-term, and a loss in the long-term can offset a gain in the short-term. For example, if your net short-term loss is $2,500 and your net long-term gain is $3,500, then you need to pay taxes on $1,000.
Deduction and Carry Forward
You can deduct a loss of up to $3,000 from other income as well. If you had a loss of more than $3,000, then you can carry it forward to the next year and pay taxes on it in that year. You can then deduct the loss from the capital gain next year.
Tax-loss harvesting is most beneficial when you hold the asset for more than one year. You can save more in taxes, as the long-term capital gains rate is likely to be lower. Long-term capital gains stands at 15% for medium and lower-income groups, and 20% for higher-income groups. Additionally, you can reinvest your savings from tax-loss harvesting, which will continue to compound until it is invested.
Reporting to the IRS
To claim a deduction, you need to fill out Form 8949 Sales and Other Dispositions of Capital Assets, and Form 1040 Schedule D. Most taxpayers need to file only Schedule D to report capital gains and losses. However, some taxpayers may additionally need to file Form 8949 along with Schedule D.