Capital Loss Carryforwards

The plain answer

When your capital losses exceed your capital gains for the year, the unused loss does not disappear. It carries forward to future tax years and can offset future capital gains. Tax law also allows a limited amount of net capital loss to offset ordinary income each year.

This can lower future taxes, but the tax benefit should not drive an otherwise poor investment decision. Do not spend a dollar to save thirty cents in taxes.

How it actually works

Start by netting capital gains and losses for the year. Short-term items are netted against other short-term items, and long-term items are netted against other long-term items. The resulting short-term and long-term amounts are then combined under the capital gain netting rules.

If the final result is a net capital loss, a limited amount set by tax law may reduce ordinary income for that year. Any loss left after that carries forward to the next year. The process repeats in later years until the carryforward is used.

A carryforward generally keeps its short-term or long-term character. That matters because short-term and long-term gains can face different tax rates. A tax return may therefore show separate carryforward amounts even though both arose from the same year’s investing activity.

For example, suppose you end one year with losses that are larger than your gains. Part of the net loss may offset ordinary income under the annual limit. The rest moves into the next year, where it enters the capital gain calculation alongside that year’s sales.

Carryforwards are created by realized losses, not by investments that have fallen in value but remain unsold. See How Investments Are Taxed for the distinction between changes in market value and taxable events.

What this means for you

Keep the capital loss carryforward worksheet from your tax return. Your brokerage statement records transactions, but it may not know the carryforward reported on prior tax returns, especially if you changed brokers or tax software.

Before selling an investment for a tax loss, confirm that the trade still fits your portfolio. Tax-Loss Harvesting can explain how losses may be captured while maintaining an investment plan, including rules that can delay or disallow a loss.

If you have a carryforward, it may make realizing a gain less costly than it otherwise would be. That does not make the gain tax-free in every case. The result depends on the carryforward’s character, other gains and losses, and the tax rules in effect for that year.

Common mistakes

• Assuming an unused loss expires after one year.
• Confusing an unrealized market decline with a deductible capital loss.
• Losing track of the carryforward when changing tax preparers or software.
• Assuming a brokerage will automatically import prior-year carryforwards.
• Selling a sound investment only for a tax benefit.
• Ignoring state rules, which may differ from federal rules.

Related pages

• Tax-Loss Harvesting
• How Investments Are Taxed
• Taxable vs. Tax-Advantaged Accounts