Capital Loss Tax Deduction Limit
The tax treatment of losses is easy to understand once the basics have been grasped.
While capital losses may be used with no limits to reduce capital gains, the amount by which ordinary income may be reduced by capital losses is limited to $3,000 (or $1,500 each if married filing separately). Thus, the amount entered on Line 13 of Form 1040 may not exceed $3,000 regardless of the total amount lost for the year.
Any loss which exceeds $3,000 may be “carried forward" to subsequent years.
For example, if an investor has a capital loss of $10,000 for the year, only $3,000 of that loss may be deducted on that year’s taxes. The remaining $7,000 may be carried forward. Thus, if the investor has a net gain in the following year of $6,000 the carried forward loss of $7,000 may be applied to that gain resulting in a reportable “loss" of $1,000 ($6,000 gain - $7,000 carried forward loss = -$1,000 for Line 13) for that year.
So, it is very important that the investor keep all records and tax forms from the year with the capital loss until the full loss has been written off.
While losing money on an investment is never desirable, the ability to deduct capital losses may at least provide a small amount of compensation for those losses.