It would be wonderful if all of us were stock market wizards. Every stock we pick would be a winner, none of us would suffer the slightest loss of portfolio value, we’d have imported shellfish for dinner every night, and all of our friends would be hitting us up to fund their dog-sitting startup. Such a life!
Of course, that’s not the case. Every stockholder’s portfolio is going to have at least one security that just never fulfills its potential. That’s just the normal course of business. All an investor can do is arrange their holdings so that winners outnumber losers.
There will be a loser or two. Inevitably, even if it’s just once in a great while, one of the companies you own shares in will turn out to be a dud. And you’ll have to suck it up and take the loss.
But there’s a way to ease the sting of the defeat of underperforming companies: writing off stock losses as tax deductions. It’s completely legal, fairly straightforward in most cases, and potentially beneficial for longer than just the current tax year.
Can you claim stock losses on taxes? In this post, Gorilla Trades will explain how.
Stock losses are more formally called “capital losses,” the same way stock market profits are called “capital gains.” Some people call capital losses “capital gains losses,” which seems a little confusing and unnecessary, but to each their own. We’ll just call them “capital losses.”
Capital gains and losses are pretty straightforward. If your stock share value increases as you hold it, you get capital gains. If the value goes down, you experience capital losses.
Capital gains and losses, in and of themselves, are not impacted by taxes, unlike your earned income. If you just sit back and let the stocks in your portfolio alone for a year, none of your capital gains or losses will ever count on your tax bill.
But if you sell your stock shares, you cash in and take a profit or loss. That is called a “realized” capital gain or loss. Once you sell your shares and “realize” the capital gains or losses, that amount directly affects your tax bill.
Anytime you sell an asset, you realize capital gain or loss. But if your asset was sold for the purposes of investment, you can deduct some of the capital losses from your tax bill. Since everybody buys and sells stocks for investment purposes, it is completely legal to write off stock losses for tax deductions.
It’s important to note this is only acceptable for investment vehicles, not personal property you keep inside your home. In other words, you can’t sell your stamp collection and write off the realized capital loss. But realized losses from stocks, funds, and rented real estate? Deduct away.
Can you claim stock losses on taxes? You sure can.
How do you determine your eligible, realized investment losses tax deduction?
The first step is to sort your realized capital losses into two categories: short-term and long-term. Short-term capital losses are for stocks (or other investments) that you held for less than one year. Long-term losses are for stocks that you held for longer than one year.
This step is important because the tax rates for each category are different. Short-term capital losses are generally taxed at a higher rate than long-term ones. You can use both types strategically to ensure maximum tax efficiency.
To calculate your realized stock loss for a tax deduction, you’ll measure the sale price against the original cost basis. The cost basis is simply what you paid for the stock when you originally bought it, plus any brokerage or commission fees you might have been charged.
The rough calculation for determining your realized capital loss on a security is:
Number of shares sold x adjusted cost basis per share – total sales price
The result is your realized investment loss for a tax deduction. This total is the amount you can claim when you file taxes.
One more word about the cost basis: If a company ever had a “stock split” during the time you owned shares in it, you’ll have to adjust the cost basis.
Sometimes a company will split investors’ shares to create more shares. When that happens, the price of each individual share will go down. You will see this cost basis reduction reflected on your online brokerage portfolio. Just make sure you’re using the right number when calculating your capital loss.
Any year that you have capital losses, you can claim them on your tax return. Many investors use writing off stock losses to offset taxes on realized capital gains to lower their tax payouts.
However, if you don’t have any capital gains in the given year (our condolences), you can still deduct realized capital losses to offset the tax bill from your ordinary income.
The IRS allows you to deduct up to $3,000 a year in realized capital loss ($1,500 if you’re married and filing a separate return from your spouse). For reasons we suspect might be a little commitment-phobic, this is called the “marriage penalty.”
If your capital losses in any year exceed $3,000, you can carry over the excess amount into later years. For example, if you experienced realized capital losses of $11,000 in 2021, you could claim $3,000 against this year’s taxes, another $3,000 in 2022, another $3,000 in 2023, and the remaining $2,000 in 2024.
That’s all there is to calculating your realized stock market losses for taxes. Now for the fun part: the investment losses tax deduction paperwork!
To claim an investment loss tax deduction, you will need two IRS forms. The first is Form 8949: Sales and Other Dispositions of Capital Assets. It’s quite the epic production. The other form you’ll need is Schedule D, far less dramatic but still important.
Form 8949 has two parts. Part I focuses on short-term capital losses; Part II on long-term.
In Part I, short-term capital losses are calculated against short-term gains. The result is your net short-term capital gains or losses, as the case may be. This is the total profit or loss you had on commodities you owned for less than a year.
Part II is a little more complex, which is perhaps fitting for long-term capital losses. First, you’ll do the same thing that you did in Part I, but for long-term holdings. Subtract long-term capital losses from long-term capital gains.
Then, you’ll calculate your total net capital gain or loss by combining your short-term and long-term results. For example, if you had a long-term net gain of $4,000, but you had a short-term net loss of $2,500, you will only be liable for an overall capital gain of $1,500. You will then add this result to Schedule D.
If the sum of your short-term and long-term capital amounts is negative, then you’ve had an overall capital loss on the year. If this happens, you can apply the marriage penalty as described above against your ordinary earned income, up to $3,000 per year for single and joint filers.
Make sure to keep all of the paperwork for your transactions just in case the IRS would like to have a word with you, and you need to show proof of everything.
The secret to calculating your investment loss tax deduction is to use short- and long-term losses to maximize your tax benefits. It’s a little tricky but entirely doable.
As we mentioned earlier, long-term capital gains and losses are calculated at a lower rate than short-term ones. Since short-term rates are higher, it’s generally better to deduct short-term capital losses because it will have a greater impact on your annual tax bill.
Let’s put it like this: Say you have two stocks that each lost $2,000 in 2021. (Rough year, eh?) One of these stocks you’ve held for a couple of years; the other one you’ve owned less than six months. You decide you want to sell them for stock losses taxes advantages.
You could, of course, sell all of your shares and take both stock losses as tax deductions for 2021. But if you only wanted to unload one of the stocks, you’d want to sell the one you’ve held for less than a year. The tax benefits will be more significant than when selling the long-term asset.
It’s necessary to be fully aware of laws or regulations about stock losses taxes. Not only will you know what types of commodities are exempt from deduction, but you also might discover loopholes in the tax code that will work to your benefit.
What if you bet on a real lame horse and suffered capital losses on a company that went bankrupt and has liquidated all its holdings? Now that your stock is completely worthless, can you still deduct your lost value on your taxes?
Yes, you can take a capital loss on your lost stock value in a bankrupt company. But in this case, having documentation for the IRS’s probing eyes is really necessary. They will want to be convinced that the stock truly has no value and that zero value was arrived at correctly.
Any documentation that proves the company is of no worth will suffice. Canceled stock certificates are especially helpful. So is any evidence that the company no longer trades on any exchanges and no longer exists.
Occasionally a bankrupt company will offer to buy back your stock for one penny. In return, you’ll receive documentation that proves you’ve released all of your equity in the company and that you suffered a total loss of your investment. Cold comfort for a massive loss, maybe, but a nice gesture all of the same.
There are a few limitations, rules, and helpful tips for writing off stock losses for tax purposes that you should be aware of.
Anytime you sell company stock at a loss, then buy “substantially identical” shares (in other words, the same stock) within 30 days, the IRS considers this transaction a “wash sale.” No stock market losses taxes rules apply.
In the feds’ eyes, you never really gave up your stock ownership in those 30 days. You just ditched it for a couple of weeks. Because of that reasoning, a wash sale is not a tax-relevant event, according to the IRS.
In the context of this post, wash sales relate to end-of-the-year stock transactions. You can’t sell a stock for a loss on December 20, then rebuy it the next January 5, and then tell the IRS, “I deduct a capital loss on this stock for last year!” That won’t work.
You can’t deduct a realized capital loss on a stock if, for some reason, you sell your shares to a family member or relation. This restriction exists to prevent families from gaming the system through excessive stock loss tax deductions.
Taxpayers in the 10%-to-12% bracket are not liable for capital gains taxes. Therefore, they don’t have to worry about offsetting them with realized capital losses. Those who do have to pay taxes on capital gains will want to deduct capital losses against their regular income.
Are you thinking about unloading shares that are causing you financial headaches now, but do you believe the company will eventually return to profitability? Then hold onto the shares. Don’t sell them just to get the stock loss tax deduction. These shares will ultimately be far more valuable if you’re right about the future.
On the other hand, if you don’t ever see the company turning itself around, then dump them already. At least you’ll get a tax break when you file you stock market losses taxes.
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