Can the market losses be utilized to adjust tax payment?

Losses incurred in the stock market can be termed as Capital Losses. Capital Losses are said to be incurred when a capital asset such as an investment or a real estate decreases in its value. When this capital asset is sold at a price which is much lower than the actual purchase price of the asset, then the capital loss is realized.  

There are always fluctuations in the stock market and your investments might give you huge profits or even bring your losses. Losses are always demotivating; however, you can note that capital losses can be used to reduce the income tax bill which you owe to pay to the IRS.  

Tax Rules related to Capital losses

Like it is mandatory to report Capital gains as income, similarly, Capital losses can be used as deductions on your tax returns.

Capital losses are mainly of three categories which are listed below.

  • Realized Capital Loss – Realized capital loss occurs after you have sold your asset or investment. 
  • Unrealized Capital LossThese losses are those capital losses which do not need to be reported.
  • Recognizable LossRecognizable loss is defined as the amount of loss that can be declared in a given year.

According to the US Tax laws, your realized capital losses can have an impact on your income tax bill. Moreover, realized capital losses can be used for lowering the income tax bill only if the asset you have sold was owned for investment. Also, you need to think wisely and create realized capital loss; for instance, if you sell a coin collection for a price lower than its cost price intending to utilize it as a deduction on income tax bill it would not be acceptable.

 

Determination of Capital Loss

  • For calculation related to income tax purposes, 
  • Amount of capital loss = Number of shares sold, times the pre-share adjusted cost basis – the total sale price.
  • Cost Basis price refers to the fact that it provides the basis from which any capital gains or capital losses are figured, of the stock share, is the total of the purchase price and any fees(such as any commission or brokerage fees).
  • There is a need to adjust the cost basis price if there was a stock split during the period you had owned the stock. You will have to adjust the cost basis concerning the magnitude of the stock split.

Deduction of Capital Losses

  • Capital losses can be used to offset the capital gains in a taxable year. By this, you would be able in the removal of some portion of your income from your tax return.
  • A capital loss can be used by you to offset your ordinary income but up to a limit of $3000 in a year in case of a lack of capital gains by which you would have been able to offset your capital losses.
  • If you are willing to deduct your stock market losses, then you would have to fill Form 8949 and Schedule D while filing tax returns.
  • Your short term capital losses would be calculated against your short term capital gains by using Part I of Form 8949 to arrive at the net short term capital gain or loss. In case of a lack of capital gains for that year, the net would be a negative number equal to the total of your short-term capital losses.
  • Part II of Form 8949 will be used for the calculation of your net long term capital gain or loss. It would be equal to any long term capital losses minus long-term capital gains.
  • The next step is the calculation of the total net capital gain or loss by a combination of your short-term capital gain/loss and the long-term capital gain/loss. The resulting figure would be entered into Schedule D Form.
  • If your net figure obtained is a negative number (the difference between short term and long term gains/losses) which indicates an overall capital loss then this loss is deductible from any other taxable income with a limit on the amount set by the IRS.
  • For taxpayers, filing tax returns as Married and filing jointly the maximum amount deductible from total income is $3000. However, for taxpayers filing tax returns as Single or Married and filing separately the maximum deduction permissible is $1500. Moreover, if the amount of your net capital loss is more than the permissible limit you can carry it forward for the next taxable year.

Hence, you must attempt to take your tax-deductible capital losses in a very tax-efficient manner to have maximum benefit. Choosing a short-term capital loss for tax deduction would be more advantageous than that of a long-term capital loss. In general, you should opt for taking any capital loss in the year in which you are tax-liable for short-term gains or in which you have obtained zero capital gains as this would help in saving on your ordinary income tax rate.

References

https://www.investopedia.com/articles/investing/062713/capital-losses-and-tax.asp

https://www.investopedia.com/articles/personal-finance/100515/heres-how-deduct-your-stock-losses-your-tax-bill.asp#:~:text=Deducting%20Capital%20Losses&text=If%20you%20don’t%20have%20capital%20gains%20to%20offset%20the,forward%20to%20future%20tax%20years.)