Deduct Capital Loss the Right Way and Save on Your Taxes

Losing money on a stock is never ideal, but the silver lining is that you can often get a tax break by selling a losing stock. To do so, though, you have to deduct capital losses in the best way possible. Let's take a closer look at the proper way of deducting capital losses to maximize the tax benefit.

What realized capital loss isIn tax law, "realized" losses and gains refer to investment losses or profits that can be used on your taxes. A loss on stock is not realized unless you have sold the shares. If your stock shares went down $10,000 in value and you did not sell the shares by the end of the year, you do not have a loss that can be deducted. Furthermore, you cannot sell the shares to book the loss and then buy them right back. If you repurchase shares that you sold within 60 days, the transaction is called a "wash sale" and the loss will be disallowed for tax purposes.

Another important term in tax law is "capital gains." You realize capital gains if you sell stock or other assets at a profit. If you sell a stock at a loss, you have a capital loss. You can only claim a tax deduction if the asset was owned for investment purposes. Stock losses are nearly always deductible because stock is universally regarded as an investment. Capital gains and losses are either short-term or long-term -- the former applies to stocks owned for less than a year, and a long-term gain or loss occurs if the stock was owned for more than one year before being sold.

The right way to claim a capital lossCapital losses from the sale of stock are claimed on Schedule D, which is attached to your Form 1040 tax return. Capital losses offset capital gains of the same type, then capital gains of the other type, and then other income. So, if your stock loss is a short-term loss, it first offsets your short-term gains for the year. Any remaining short-term loss would then be used to offset long-term gains. Finally, if your loss from the sale of stock was greater than the total of your combined long- and short-term capital gains, up to $3,000 in capital loss can be used as a deduction against other income.

If your stock losses exceed your capital gains by more than the $3,000 limit that you can claim as a tax deduction, you can carry the remaining losses forward to future tax years. The loss can be used against capital gains and up to $3,000 of other income each year until the entire loss has been used to reduce your taxable income and income taxes for the year.

Being smart about deducting capital losses can help save you a lot of money on your taxes. Be sure to take full advantage at tax time in order to boost your refund as high as you can.

The article Deduct Capital Loss the Right Way and Save on Your Taxes originally appeared on Fool.com.

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