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Using long-term capital loss carryovers

Posted by Andrew Chan  April 17, 2009 09:30 PM

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Can I use a long-term capital loss carryover to offset a short-term capital gain?

In short, yes, you can offset a short-term term capital gain with a long-term capital loss carryover. However, you do need to offset the long-term loss carryover against any long-term gains before you can offset any short-term capital gains. The process of offsetting gains and losses can be confusing. Here is a step-by-step guide on grouping and offsetting different types of capital gains and losses.

Step 1: Determine which gains and losses are considered short-term vs. long-term. Short-terms gains and losses are those where your holding period (i.e., the amount of time you held the asset before selling or exchanging it) is equal to 1 year or less. Long-term gains and losses are those where your holding period is more than 1 year.

Step 2: Offset your short-term gains against your short-term losses. Be sure to include any short-term losses carried over from prior tax years. This will result in your “net short-term gain or loss”.

Step 3: Long-term capital gains tax rates vary based on the asset sold and your marginal income tax rate. For example, the long-term capital gains rate for stocks is different than for collectibles. Generally, the rate for stocks and other securities will either be zero or 15 percent (depending on your income tax bracket) whereas the rate for collectibles is 28 percent. You need to group your long-term capital gains and losses according to the capital gains rate that applies to that asset.

Once you have classified your long-term gains and losses by the appropriate long-term capital gains rate, you should offset the gains and losses within those groups. In other words, offset your long-term gains and losses within the 15 percent tax bracket, then the long-term gains and losses within the 25 percent bracket, etc. Do this for each group but don’t forget to include any long-term loss carryovers from prior tax years. This will result in a “net long-term gain or loss” for each capital gains tax rate.

The final step in calculating your overall net long-term gain or loss is to offset the “net long-term gain or loss” for each capital gains tax rate against each other. Use the losses in the lower tax bracket to offset the gains in the higher tax brackets first.

Step 4: Once you have calculated a net short-term gain or loss and a net long-term gain or loss, you can offset these against each other using the following rules:

Rule 1: If you have, both, a net short-term loss and a net long-term loss, you can take $3,000 dollars of the loss on your tax return and carryover additional losses to the next tax year.

Rule 2: If you have, both, a net short-term gain and a net long-term gain, the short-gains will be taxed at ordinary income tax rate and the long-term gains will be taxed at their appropriate long-term capital gains rate.

Rule 3: Any other combination of short and long-term gains and losses (not mentioned in Rules 1 and 2) should be offset against each other using your short-term loss to offset the higher long-term gains first. If this results in a gain, you will pay taxes at the appropriate short-term or long-term capital gains rates. If the result is a loss, you can take up to $3,000 dollars of the loss on your tax return and carry the remaining amount to the following year.

For more information about capital gains tax rates, visit the IRS’ web site at http://www.irs.gov/newsroom/article/0,,id=106799,00.html

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
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