Capital Loss Carryover

Capital loss carryover is the benefit that has been extended to the taxpayers for claiming the capital losses that were incurred during the year, to be set off against the subsequent capital gains. As per US Tax Laws, net capital losses can only be deducted up to a maximum of $3,000 in a year in the case of an individual.

The amount over $3000 needs to be carried forward to the next year till exhausted. There is no time frame within which such loss can be utilized. For corporations, their capital loss carryover limit must be utilized against the preceding three years of capital gains, and the unutilized capital losses need to be applied in the upcoming five years against capital gains.

Capital loss carryover is a provision under the United States tax laws that helps individuals to off set their capital losses within a financial year against their capital gains. The capital loss carryover rules have a specific limit for individuals applying for such a provision in their yearly tax filing.

With any tax planning, timing is an important aspect that needs to be taken care of. The capital loss carryover provisions have been incorporated to help the investors in their tax planning efforts.

It would promote tax planning instead of tax evasion practices amongst the investors, which is a healthy practice to be followed upon. Another advantage is we need to report only realized gain or losses, not the unrealized ones. Though there are shortcomings in terms of amount and uniformity, we expect that it would be streamlined in the upcoming years, with better provisions.

The formula according to the capital loss carryover rules depends on the time frame of the calculation. It is calculated differently for both short-term and long-term capital losses. Let us understand them in detail through the discussion below.

• Short Term - It refers to the assets which are held for a year or less than that.
• Long Term - It refers to the assets which are owned for more than a year.

The reason for segregation is due to the different tax rates.

If during the year, the net long-term capital loss exceeds the net short term capital gain, then the excess becomes the net long term capital loss in the following year.

First Formula

• Net long-term capital loss  -  xx
• Net Short-term capital gain  -  xx
• Net long-term capital loss   -  xx

If during the year, the net short-term capital loss exceeds the net long term capital gain, then the excess becomes the net short term capital loss in the following year.

Second Formula

• Net short-term capital loss  -  xx
• Net long-term capital gain   -  xx
• Net short-term capital loss  -  xx

Let us understand how to calculate according to the capital loss carryover rules for individuals and corporations separately to be able to understand the concept in depth.

• Purchase date.
• The purchase price, which includes any taxes or fees you paid, (improvements in the asset over time, would also form part of this cost).
• Sale date.
• Sale consideration received for the asset, reduced by any fees or cost of selling it.

#1 - Individual

Rob purchased the home in 2009 for $200,000 and paid $3000 as closing costs. Rob incurred $100,000 for improving the asset and finally sold the home in 2019 at $150,000, incurring brokerage cost of $5,000.

• Now this capital loss amounting to $158,000 would be first set off against the capital gains, and if there are none, then it would be offset against the ordinary income.
• Say, Rob has an ordinary income of $ 50,000, then in the particular calendar year, he would be entitled to deduct $3,000 of capital loss, and rest would be carried forward indefinitely.
• So, in this scenario, Rob’s ordinary income would be $47,000, and the rest of the capital loss $155,000 would be carried forward to the following year.

#2 - Corporations

Apple Inc. has a capital loss of $100,000 in the year 2019. The past three years capital gain look like this –

• 2018 - $ 35,000
• 2017 -  $0
• 2016 - $ 45,000

Going per the law, $100,000 can be offset against the 2016 capital gain of $45,000, with the residual loss being $55,000.

• As there is no capital gain in 2017, so the capital loss would be $55,000;
• Coming to the year 2018, $55,000 loss can be set off against the gain of $35,000, leaving us with a loss of $20,000.
• Thus, a $20,000 loss would be carried forward to the next five years.

Let us understand the concept of capital loss carryover limit with the help of a couple of examples.

Example #1

Melissa had been investing in the stock market for the last 24 months. However, in the current financial year, she realized her overall losses in the last 12 months.

Upon discussing with her auditor, it came to light that she could off-set these capital losses against the capital gains made with her other investments. However, the losses amounted to $4,250.

While filing the annual taxes, Melissa’s auditor was able to claim the carryover for $3,000 and paid taxes for the remaining $1,250.

Example #2

The cryptocurrency market lost an aggregate of $1.4 trillion in 2022 due to liquidity issues and a series of bankruptcies.

For investors who sold their Bitcoins and other such coins at a loss, they can offset those losses with the profits in their portfolios to blunt the heavy impact of the losses made in the year.

However, it is important to know that the deductions would only be limited to $3,000 as cryptocurrencies have no wash sale rules.

Capital loss needs to be claimed in the IRS Form 8949 as per the capital loss carryover limit, Sales and Other Disposition of Capital Assets, with the tax return. In addition to this, capital gains and losses and tax loss carryforwards are reported in Schedule D of IRS Forms also.

Let us understand the advantages of following the capital loss carryover rules through the discussion below.

• Saving money - Capital loss carryover acts as a very useful tax planning tool in the hands of an investor. The prolific gains they have made on other investments can be offset by the loss-making shares, thereby reducing their tax liability.
• Indefinite Life - Increasing the lifetime of capital losses to infinite has reduced the stress of investors as now, they need not worry about the loss of getting extinguished due to limited life. It promotes tax planning rather than tax evasion practices amongst the taxpayers.

Despite the several advantages mentioned above, there are a few factors that make capital loss carryover limit a hassle. Let us understand the disadvantages of these rules through the points below.

• Meager Amount - The loss that can be set off in a particular year is $3,000, which is very meager for investors who deal in the stock market daily as substantial losses can take years to use, with a little tax benefit.
• Lack of Uniformity - The capital loss tax laws change according to the state in which the taxpayer lives in. In New York, federal loss carryforward rules are being followed, whereas New Jersey does not follow the same. While federal tax laws are cumbersome, state and local laws act as fuel to the fire, raising additional complexity in the understanding of the law.The capital loss tax laws change according to the state in which the taxpayer lives in. In New York, federal loss carryforward rules are being followed, whereas New Jersey does not follow the same. While federal tax laws are cumbersome, state and local laws act as fuel to the fire, raising additional complexity in the understanding of the law.