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Thursday, March 17, 2011

Capital loss carryover explained

A 'capital loss carryover' is the use of un-deducted investment losses for the purpose of reducing taxable income. In other words, the capital loss carryover provision in the IRS Tax code allows tax payers to use loss from sales of capital assets as deductions to future years' taxes.

To illustrate capital loss carryover, if Mrs. Smith loses $10,000 in the stock market in 2010, but is only allowed to deduct $3000 of those losses from 2010's taxable income, then the remaining $7,000 can be deducted in increments of $1500-$3000 (1) for subsequent years until the loss is exhausted. 

Benefits of capital loss carryover

There are several benefits of capital loss carryovers. These benefits allow investors to reduce their exposure to investment risk, liability and potentially serve as a tax planning tool that can extend tax savings. The following video by Free Tax USA details the concept of capital loss carryover further.

To illustrate via example, in 2010 the tax bracket for single filers with income over $171,851 was 33 percent of the amount over $171,850 plus $41,827.25.(2) If a 2010 single tax earner making $173,000 in taxable income is able to deduct $3000 in capital loss this places her in the 28% tax bracket.

The tax savings plus the capital loss carryover loss reduction add up to nearly $897 for $3000 of loss. Moreover according to the 2010 tax rates, $41,827.25 + .33($1,150)=$42,206,75- .28($87,600)+$16,781.25=$41,309.25. Since $42,206.75-$41,827.25=$897.00, nearly 30% of the capital loss carried over is eliminated through tax savings. The benefits of capital loss carryovers are listed below.

• Reduces income tax
• Lowers risk of investing
• Eliminates a percentage of capital loss
• Provides incentive to invest
• Can be deducted indefinitely

How to determine and carry over capital loss

Capital loss carryovers are legislated by Title 26, Subtitle A, Chapter 1 of the U.S. Code. (3) Capital loss carryover is calculated and carried forward fairly simple. Several forms and/or documents are needed to calculate, verify and record the capital loss carryover. These forms serve as proof of the capital loss carryover and should be kept for as long as an outstanding capital loss carryover balance exists.

IRS Forms needed:

• IRS Form 1040
• IRS 1040 Schedule D Line 16
• Capital Loss Carryover Worksheet P.D-7
• 1099 MISC

For capital losses extended over multiple years, excess capital loss must be recorded on the following year's Schedule D using the capital loss worksheet. For example, if in 2009, $3000 of $6000 in long term capital loss is deducted from income, then the remaining $3000.00 is recorded on line 15 of the 2009 Capital Loss Worksheet and on line 14 of the 2009 Schedule D.(4)

For a skipped year of capital loss carryover an amended IRS 1040 and/or Schedule D and Capital Loss Worksheet may need to be filed to update the amount of capital loss carried forward. Additionally, according to the IRS, each year of unused capital loss carryover must be 'reflected' in the capital loss carried forward.

To illustrate skipped capital loss carryover further, the amount of capital loss for a skipped year should be deducted from the total unused capital loss. For example, if in 2007, $9000 of capital loss was incurred but not used, in 2009 only $3000 of capital loss would be able to be used. For additional clarification, contacting the IRS at 1-800-829-1040 for further instructions may be helpful.

Capital loss carryover tips

When deciding whether or not to use a capital loss carryover or to determine if one qualifies for the capital loss carryover it can be helpful to be familiar with the IRS tax code, tax planning techniques and capital loss carryover rulings, instructions and uses.

• Cost basis is added to sale price ex. Transaction fees
• Capital loss in excess of $3000 can be used in a following tax year
• If Married filing separately, maximum annual capital loss claim is $1500
• A capital loss carryover is not the same as a 'capital loss carryback'
• Capital loss carryover can be used as long as there is some left
• Capital assets include real property and personal property

In summary, using capital loss carryovers are a way to lower tax costs via loss on the sale of capital assets which include a wide range of property such as real estate, stocks, and bonds. Capital loss carryovers are the use of capital loss from a previous year in which a capital loss was not utilized. It is useful to keep good records of capital losses and to prepare them accordingly in order to benefit from this tax incentive.


1. http://www.irs.gov/taxtopics/tc409.html (IRS: Capital loss carryover)
2. http://bit.ly/c2Kf6h    (Money-zine tax rates)
3. http://bit.ly/8ZVMbf   (Law Cornell: US Code)
4.  http://bit.ly/bEGbgp (Schedule D: '09 Instructions)
5. http://bit.ly/77iBsY    (Schedule D: 2009)