So you’ve suffered an investment loss this tax year. That’s always uncomfortable, especially in a bull market, but it’s not the end of the world. One silver lining you may not know about is that you can use the loss to your advantage on your taxes. Tax law allows you to write off certain losses each year. Here’s what you should know about investment losses and what to know about accounting for them on your taxes, especially during a divorce.
What Is an Investment Loss?
An investment loss occurs any time you invest money in something and sell it for less than you bought it for. For example, if you buy $1000 in stock and sell it later for $900, you’ve suffered an investment loss of $100.
It’s important to note that you can only write off up to $3000 in investment losses per year, total. This deduction counts against your personal income. If you buy $10,000 worth of stocks in April and sell them in October for $4000, only $3000 of the total $6000 difference can be written off.
This counts for both your short-term and long-term investments. Short-term investments are those that you’ve owned for less than a year, while long-term is anything that exceeds the 365-day threshold. You can deduct short-term losses from short-term gains, likewise with long-term investments.
The Process of Writing Off Investment Losses on Taxes
The question of the best way to write off capital losses can be quite complex, depending on your finances. It’s never a bad idea to work with a team of professionals if you have concerns about your taxes.
However, in a simple investment loss scenario, the answer is straightforward. It’s likely that the best way to write off the amount is through a standard Schedule D deduction, and then carry over the remainder to the next tax year. Here’s how to accomplish that.
1. Collect Documentation
You should collect all the relevant information about your deduction while you’re doing your taxes. It’s best to collect all the documentation before submitting your taxes so you’re confident you can prove the deduction is valid.
Documentation to collect includes:
- Receipts proving the purchase date and amount of all relevant assets
- Statements showing the status of the asset over time
- Receipts and documentation showing the sale date and amount of the investments
- Any other documents you believe may be relevant
2. Report Original Purchase and Sales Price
Next, you can begin to record the amount lost on your taxes. You’ll be performing the deduction on your Schedule D. List both the date of the original purchase and the date it became “uncollectible.” For stock investments, this is the day that you sold it for less than what you bought it for.
You’ll also list the “sales price” on your Schedule D. This is the amount you recovered from your investment. With stocks, this is the amount you sold your stocks for.
3. Calculate Total Amount Lost
In Schedule D’s “Gains or Loss” section, you’ll determine how much you actually lost. This may be simple subtraction if you only bought and sold one stock, or the math may be more complicated if you perform regular trading. Run your calculations several times to ensure that your number is correct.
Note that you must always list a loss as a negative number. Without a negative sign, your lost funds may be interpreted as a profit, which would incorrectly alter your final tax burden.
4. Carrying Forward Capital Losses to Offset Capital Gains
Finally, carrying forward your capital losses is invaluable. If you lost $10,000 in the tax year 2020, you could write off $3000 for 2020 and carry forward $7000 to 2021. Then in 2021, you can write off an additional $3000, carrying $4000 forward to 2022. As a result, a single year’s lost funds can actually improve your taxes in future years.
Furthermore, if you experience investment gains, you can balance those against your past loss. For example, if you’ve carried forward $7000 and you had gains of $5000 in 2021, then you could cancel out the gains entirely and deduct $2000 on your 2021 taxes.
Investment losses are painful, and so is divorce. But writing them off on your taxes doesn’t need to be. By writing off your $3000 limit and carrying the remainder forward to the next year, you can make your losses work for you.