Capital loss carryover allows taxpayers to apply capital losses from previous tax years to future tax returns to offset capital gains and, in some cases, ordinary income. Capital losses occur when an asset, such as stocks or real estate, is sold for less than its original purchase price. If a taxpayer’s capital losses exceed their capital gains for a given year, the excess loss can be carried forward to future years.
Here’s how capital loss carryover works:
- In the year of the loss, taxpayers can use capital losses to offset capital gains in full. If there are no capital gains or the losses exceed the gains, up to $3,000 of capital losses can be used to reduce ordinary income each year ($1,500 if married filing separately).
- Any remaining losses can be carried forward to future years indefinitely, where they can offset future gains or continue reducing ordinary income by $3,000 annually.
For example, if a taxpayer has $10,000 in capital losses and only $2,000 in capital gains, they can use the $2,000 to offset the gains and apply $3,000 to reduce their ordinary income. The remaining $5,000 in losses would be carried over to future tax years.
This tax strategy helps taxpayers manage their overall tax liability by spreading out losses over multiple years and reducing taxable income. It is especially useful for investors who experience significant market downturns or who sell assets at a loss but expect gains in future years.