What Is a Short-Term Loss?
The term short-term loss generally refers to a loss taken after the sale or disposition of a capital asset that is owned for a year or less. A short-term loss is realized for federal income tax purposes when the asset is sold for less than the original purchase price. This includes assets like stocks, bonds, and real estate investments. As such, it reflects a decline in the value of the asset. You can still realize a loss on assets for personal use like a principal residence or automobile but they cannot be claimed for tax purposes.
Key Takeaways
- A short-term loss is a loss taken on the sale or disposition of a capital asset held for 12 months or less when the sale price is lower than the purchase price.
- A deductible short-term capital loss is a loss realized on the sale of investment property that has been held for one year or less.
- The amount of a short-term loss is the excess of the adjusted tax basis of the capital asset over the amount received for it.
- Short-term losses offset short-term capital gains first while long-term losses offset long-term gains.
- If the net result of offsetting calculations is a loss, the taxpayer can deduct up to $3,000 of the net capital loss against ordinary income for the year.
How Short-Term Losses Work
When you sell anything, you can end up with a gain or a loss. If the sale price is greater than the original purchase price, you end up with a gain. A loss results if the sale price is lower than the original price. Losses (and gains) can be long-term or short-term, where the former is realized on assets held for 12 months or more while the latter is realized for assets held for 12 months or less.
Certain losses are tax deductible, As noted above, you cannot claim deductions on losses for personal property, such as your primary residence or vehicles. But you can on other assets like investments, including stocks, bonds, and real estate investments. These are known as short-term capital losses. You can calculate and declare all short-term losses (and gains) on Part II of the IRSSchedule Dform. This means:
- If a taxpayer has long-term capital gains and losses for the year, the long-term losses must be offset against long-term gains.
- Then any short-term losses can offset long-term gains or vice versa.
- Net losses of either type can then be deducted from the other kind of gain.
If the net result of these offsetting calculations is a loss, the taxpayer can deduct up to $3,000 of the net capital loss against ordinary income for the year. A net loss in excess of $3,000 (or $1,500 for those married filing separately) must be deferred until the following year.
For example, if a taxpayer realizes a net capital lossof $10,000 in 2023, $3,000 of the loss can be deducted in calculating the taxpayer's tax liability for that year, which is the year of the loss. The remaining $7,000 of losses can be carried forward. Assuming no additional capital gains or losses, the taxpayer can deduct $3,000 of the losses in each of the next two years, 2024 and 2025, and can deduct the final $1,000 in 2025, the third year following thesale of the assets.
Losses (and gains) can be realized or unrealized. A realized loss occurs when you actually dispose of the asset while an unrealized loss occurs when the asset loses value but isn't sold.
Special Considerations
An unrealized short-term loss refers to the decline in the value of an asset held by a taxpayer for a year or less to an amount below its adjusted tax basis.
An asset’s adjusted tax basis is its total acquisition cost (the purchase price plus related costs such as taxes and commissions) increased by the cost of any improvements and reduced by cost recovery deductions. This may come in the form of depreciation or amortization, if any, claimed in determining income tax liability.
Net capital losses, whether short-term or long-term, are limited to a maximum deduction of $3,000 per year, which can be used against earnings or otherordinary income.
Short-Term Loss vs. Long-Term Loss
As noted above, losses can be deemed short-term or long-term. Remember, a short-term loss is one that occurs on the sale or disposition of a capital asset that's held for 12 months or less. A long-term loss, on the other hand, occurs when there's a loss on a capital asset that is held for 12 months or more.
Taking short-term losses offers a greater tax benefit compared to long-term losses to investors. That's because they are used to offset any short-term gains you may have from the sale of your capital assets. These gains are taxed at a higher rate than others.
Examples of Short-Term Losses
Capital losses can produce tax savings in addition to offsetting capital gains and eliminating the tax liabilities associated with them. So if you have $1,000 in short-term loss and $500 in short-term gains, the net $500 short-term loss can be deducted against your net long-term gain, should you have one. If you have less than $500 of net long-term gain, the unused excess capital loss can be deducted from ordinary income and thus can wipe out the tax liability on the $500 of ordinary income.
For most taxpayers, the tax savings on long-term capital gains that are offset is either zero or 15% of the gain; for higher-income taxpayers, the savings are 20% of the gain. However, tax deductions for losses offsetting up to $3,000 of ordinary income for a year can result in greater savings for taxpayers whose income falls into the income tax brackets between 22% and 37%.
If you have an overall net capital loss for a year, you can deduct up to $3,000 of that loss against ordinary income, such as your salary and interest income. If your marginal tax rate is 22%, a $3,000 deduction from ordinary income will reduce your tax bill for the year by $660. That saving changes to $1,110 if the marginal rate is 37%.
Because of progressive tax rates, the higher your marginal tax rate, the greater the tax savings from such deductions. Taxpayers can carry over any unused excess net capital loss to subsequent years and deduct the excess in the later years. As noted above, when you're married and filing separate returns, the annual net capital loss deduction limit against ordinary income is only $1,500.
What Is a Short-Term Capital Loss?
For tax purposes, a short-term capital loss is loss from the sale or other disposition of a capital asset that has been owned by the taxpayer for one year or less. The amount of the loss is the excess of the asset’s adjusted tax basis over the amount received from the asset’s disposition.
Can I Claim a Tax Deduction for a Short-Term Capital Loss?
Yes. Short-term capital losses can be deducted against short-term gains. Any excess short-term losses can then be deducted against net long-term capital gains. Any remaining net capital losses, whether short-term or long-term, can then offset up to $3,000 of ordinary income, such as earnings and interest income for the year. If the excess net capital losses for the year are more than $3,000, the remaining unused capital losses can be carried forward and deducted in future tax years in accordance with the rules for capital loss deductions.
Can I Take a Short-Term Loss Deduction on Any Type of Capital Asset?
No, you cannot take a short-term loss deduction on any type of capital asset. Both short-term and long-term capital loss deductions can be claimed for realized losses on capital assets that were held for investment. This includes assets like stocks, bonds, and investment real estate. Tax code rules on offsetting capital gains and the annual $3,000 limitation on deductions for net capital losses apply. However, no tax deductions are allowed for either short-term or long-term losses realized on capital assets that were held for personal use, such as a residence or personal automobile.
The Bottom Line
All capital losses, including short-term capital losses, can provide taxpayers with tax-savings deductions, subject to the tax code's rules for offsetting calculations and its ceilings on deductions against ordinary income. The calculation of the deductible amount of short-term losses for a year requires netting such losses first against short-term gains and then against net long-term capital gains—if any.
If unused capital losses remain, a maximum of $3,000 of net capital losses, whether short- or long-term, can be deducted annually to reduce ordinary income. However, married taxpayers who file separate tax returns are subject to an annual ceiling of $1,500 for such losses. Any unused capital losses in excess of the applicable ceiling can be used in future years.
Taxpayers should be aware that losses on some capital assets are not deductible. They can claim deductions for capital losses, whether short-term or long-term, on the sale or other taxable disposition of investment assets held for a year or less. But losses on assets held for personal use, such as a residence or automobile, are not deductible.
