Author Topic: Short term losses  (Read 1091 times)

HipGnosis

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Short term losses
« on: April 27, 2015, 05:54:49 PM »
Are short term capital losses treated any different by the IRS than long term losses?

Cathy

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Re: Short term losses
« Reply #1 on: April 27, 2015, 10:09:21 PM »
Here is some information on the general tax framework of capital gains and losses for individuals.

In figuring your tax, you first need to determine whether you have a "net capital gain", "net capital loss", or neither, as those terms are defined in 26 USC 1222.

A "net capital gain" is the amount by which your net long-term capital gains exceed your net short-term capital losses. If you have a "net capital gain", then the tax you would otherwise pay on your taxable income is reduced according to 26 USC 1(h) and the provisions referenced therein (commonly referred to as the favourable rate for long-term capital gains and qualified dividends). Given a fixed taxable income, you would like to have as large as possible of a "net capital gain" because then you will pay less taxes.

The next topic is deductions.

The rules for determining the deduction you can take in the current year are found in 26 USC 1211(b), which provides that you can take a deduction equal your capital gains plus the smaller of (i) $3000 (or $1500 for married filing separately), or (ii) the amount by which your capital losses exceed your capital gains. You will notice that for the purpose of this rule, there is no distinction between short-term or long-term holding periods. This rule is commonly (and incorrectly) stated as limiting the capital loss deduction to $3000, but it's actually $3000 plus your capital gains. The deduction is capped at your total amount of capital losses.

For an individual, you have a "net capital loss" if your amount of otherwise-allowable capital losses exceeds the deduction that you can take for capital losses in the present year. If you have such a "net capital loss", then 26 USC 1212(b) provides two formulas that calculate how much short-term and long-term loss you can carry forward to the next year.

The short-term capital loss carryforward is equal to the magnitude of the net short-term capital loss, minus the amount by which your capital loss deduction for the current year exceeded your capital gains, minus the net long-term capital gain.

The long-term capital loss carryforward is equal to the magnitude of the net long-term capital loss, minus the amount by which your capital loss deduction for the current year exceeded your capital gains, minus the net short-term capital gain.

Let's consider a hypothetical taxpayer who has the following capital gains and losses:

Short-term capital gain: $4000
Short-term capital loss: $500
Long-term capital gain: $5000
Long-term capital loss: $6000

This taxpayer:
  • does not have a "net capital gain", and
  • does not have a "net capital loss", so there is nothing to carry forward to the next year, but
  • does have a deduction of $6500 for capital losses in the current tax year.

If this was the taxpayer's only income, she would be taxed on $2500 at ordinary income rates. The $2500 is computed by adding up the gains ($4000+$5000) and then subtracting the $6500 deduction. There is no special rate applied because the taxpayer does not have a "net capital gain".

This is a very technical subject where it is very hard to state everything correctly without accidentally slipping up and making a mistake. I believe I stated everything correctly above, but that is not guaranteed.
« Last Edit: April 27, 2015, 10:27:14 PM by Cathy »