Capital Loss Carryover
Not every investor can be successful. In fact, most are not. Some 98% under-perform their relevant index fund comp each year. That’s just a nice way of saying more people are bad at trading than people who are good at it.
Although every trade is not a zero-sum game, some people lose a lot of money every year. Even though the IRS takes as much as it can, it does give losing investors a bit of a break every year in the form of being able to deduct their losses.
Whether your company loses money or you lose your shorts investing, you can write off a certain amount of these losses on your taxes. The law says you can have a capital loss of your Schedule D of up to $3,000 if you’re married. If you’re single, you can file a $1,500 loss.
So, what’s the point of this? Well, some people lose more than $3,000 each year.
Let’s just say that you lose $7,000, and you’re married. To compensate, the IRS allows you to carryover up to $3,000 per year, meaning you can carryover $3,000 in Year 1, $3,000 in Year 2, and $1,000 in Year 3. Those losses can also be deducted from taxable gains the following year.
So if in Year 2 you earned $5,000 trading, you can deduct that carryover loss of $3,000, and only have to pay taxes on the difference...or $2,000.
There’s no limit to how many times you can carryover losses. But remember, the goal is to actually make money.
So, don’t act like this provision is a good thing. Treat it more like a mulligan.
Related or Semi-related Video
Finance: What is a Realized Gain or Loss...2 Views
finance a la shmoop what is a realized gain or loss hey whoa whoa yes those are
all the sounds of realization oh and golly gee willikers yes that too well [Man looking surprised]
when you realize a gain or loss it means that you've turned an investment into
cash if your investment has been profitable then you've realized a gain [Cash stacks landing on each other]
and goes the other way too if you've made an unwise investment and are now [Man placing bets on roulette table]
living in a van down by the river well then you probably realized a loss and
you probably also realized the importance of owning real estate that [White van moving into river]
doesn't roll why is it important to understand realized gains and losses
rhymes with shmaxes well the government at least thus far does not tax Americans
on the assets they have rather it taxes them only when they convert those assets
into cash assets like stocks bonds real estate appreciated crayon drawings that
got sold on eBay for a big price if someone pays you cash then its taxable [eBay crayon listing appears]
the idea being that an investment in a vacuum by itself isn't all that useful
like owning shares in a private company that's probably worth a lot more but may
or may not be worth anything later when you go to sell it or even if that
company's public you own a lot of shares in it well until you turn them into cash [Shares transform into cash]
nothing is certain because even public companies can go down a whole lot in
value so the government keeps its sticky paws off of those things things that are
just investments and only comes a-knockin when the investments are
converted into cash and you know that cash can be used to do stuff like buy [Investment assets transform into pile of cash]
cars and pay tuition and rent and get the occasional multicolored water slide
for the front entryway one big double yellow line on the highway is crossed [Car driving along highway]
after one year that is when you've made an investment and held it for at least a
year and then you go to sell it well you generally get a lower tax rate
applied to you then you would have had you held that investment less than a
year why well if you're holding it a year the government wants to reward you [Man holding stocks]
and it makes the markets more stable when you hold the investments
long period of time so they give you a tax break by encouraging people to marry
investments holding them many years instead of just dating them for a few [Man at altar with investment bride]
weeks while one goal the politicos have is to create a more stable predictable
investment climate it makes a lot of sense all right and predictable is good
like a pun at the end of a shmoop video oh we barely got one in there [Man sitting on a bench and bear appears]
Up Next
What is tax loss carry-forward? We promise it's a real thing, not just a bunch of words strung together.