Discussing capital losses with clients isn’t usually much fun, because it involves the loss of money. The good news is that when we sell a position with a capital loss, it creates a taxable loss. And capital losses can be used to offset capital gains. If a taxpayer has taxable losses in excess of their capital gains, then they can deduct up to $3,000 of those capital losses against their ordinary income.
For example, a taxpayer with an income of $100,000, realized gains of $10,000, and realized losses of $15,000 is in a good position from a tax standpoint. The losses of $15,000 offset the gains of $10,000. In addition, since they have $5,000 of ‘extra’ capital losses, they can use $3,000 to reduce their income to $97,000 from $100,000 – in essence further reducing their tax bill. The remaining $2,000 of capital losses can be carried forward to the next tax year to offset capital gains in that year.
In other words, capital losses are bad… until the tax benefit comes along.
Short-term capital losses are a particularly prized item when we have short-term capital gains, because short-term gains are taxed as ordinary income, which has a higher tax rate than long-term gains. This year, we have a fair amount of both short and long-term capital gains. However, we also had a short-term loss in a 20-Year U.S. Treasury position that we purchased on November 15, 2012. We bought the position in case of a market collapse due to political turmoil.
Last month, we sold that position, and the short-term capital loss can be used to offset short-term capital gains. Obviously every person’s situation is different and no one likes to lose money, but when you get your 1099s next year those short-term losses will help ease your tax bill more than the long-term losses. Please contact your Pinnacle Wealth Manager if you have any questions about your individual portfolio.
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