Loss Limitation and Carryover
By Kaye A. Thomas
Current as of April 24, 2013
Capital loss not used because of the $3,000 limitation may be carried over to later years.
Your capital loss for any tax year applies first against capital gain. Any additional loss can be deducted against ordinary income up to a limit of $3,000 per year.
Example: You have $10,000 of capital gain and $12,000 of capital loss. The capital loss reduces your capital gain to $0, and you claim the remaining $2,000 of capital loss as a deduction against your ordinary income.
Example: You have $5,000 of capital gain and $12,000 of capital loss. You’ll use $5,000 of the capital loss to reduce your capital gain to $0. You have another $7,000 of capital loss, but you can deduct only $3,000 against ordinary income. The remaining $4,000 produces no tax benefit this year, but carries over to the next year.
The $3,000 capital loss limitation is not adjusted for inflation, and has been unchanged since 1978.
Character of loss
If your overall capital loss includes both short-term and long-term loss, the part deducted against ordinary income comes first from the short-term loss.
Example: You have $2,500 of short-term loss and $2,500 of long-term loss, with no capital gain. Your overall capital loss is $5,000, and you deduct $3,000 of that amount against ordinary income. This deduction comes first from your short-term loss, so you’re left with $2,000 of unused long-term loss.
This rule is unfavorable in that you would rather preserve short-term loss for later use, because it counts first against short-term gain that would be taxed at higher rates. Yet the rule makes sense because you’re using this portion of your loss against ordinary income.
Loss that remains unused because of this limitation can be carried over to the next year, retaining its character as short-term or long-term loss. The carryover loss is added to any other capital loss you may have that year and allowed subject to the same limitation. Any loss that remains unused in the carryover year will again carry over to the next year.
Example: In year 1 you have $22,000 of capital loss and no capital gain. You deduct $3,000 and a capital loss of $19,000 is carried over to year 2. In year 2 you have (in addition to this carryover) capital gain of $8,000 and capital loss of $2,000. Your carryover is added to the capital loss, for a total of $21,000. Of this amount, $8,000 is applied to the year 2 capital gain, another $3,000 is allowed against ordinary income, and the remaining $10,000 carries over to year 3.
There is no limit to the number of years you can carry a capital loss forward. However, you are not allowed to carry a capital loss back to a year before the capital loss occurred.
- The capital loss limitation is one of the most important facts of life in the tax world of an investor. It creates an asymmetry of critical importance: large capital gains are fully taxable, but large capital losses are only partly deductible.