How Capital Losses Offset Capital Gains: Netting and Carryovers

Capital losses offset capital gains dollar for dollar: you net them within each holding-period category first, then across categories, and if losses still exceed gains you can deduct up to $3,000 of the remainder against ordinary income and carry the rest forward. That is the core of how capital losses offset capital gains under federal tax law, and the rules below fill in the sequence, the limits, and the traps that decide how much benefit you actually keep.

The Netting Sequence

Every gain or loss falls into one of two buckets based on holding period. One year or less is short-term. More than one year is long-term.¹ You don’t just add everything up. The IRS requires a specific order.

First, total your short-term gains and short-term losses separately. Do the same for long-term. Short-term losses reduce short-term gains inside their own bucket; long-term losses reduce long-term gains inside theirs. Only after that internal step do losses cross over: a net short-term loss reduces any net long-term gain, and a net long-term loss reduces any net short-term gain.²

The order matters because the two buckets are taxed at very different rates. Net short-term gains are taxed at ordinary income rates, which run from 10% to 37%.¹ Net long-term gains are taxed at preferential rates of 0%, 15%, or 20% depending on taxable income. A loss that erases a short-term gain saves you more than the same loss applied to a long-term gain, because the short-term gain would have been taxed higher.

One quirk catches fund holders. Mutual fund capital gain distributions are always long-term, no matter how briefly you’ve owned the fund.³ They enter the netting process on the long-term side, reported in Box 2a of Form 1099-DIV.

The $3,000 Ordinary Income Deduction

When total losses exceed total gains after netting, the leftover doesn’t just sit there. You can deduct up to $3,000 of net capital loss against ordinary income, including wages, interest, and business earnings.² That deduction reduces adjusted gross income directly, which can improve other tax figures tied to AGI.

The $3,000 figure is fixed by statute and not adjusted for inflation. If you’re married filing separately, the limit is $1,500.² The cap keeps investors from wiping out significant earned income through investment losses in a single year.

Carrying Losses Forward

Any net loss above the $3,000 deduction carries forward to the next year. For individuals, there is no expiration. A loss from a crash a decade ago is still usable if you’ve tracked it.⁴

The carryover keeps its original character. A long-term loss stays long-term when you finally use it, and a short-term loss stays short-term. Each year, you apply the carried loss in the same sequence as fresh losses: against capital gains first, then up to $3,000 against ordinary income. You can’t skip a year to save the deduction for a better one. If you miss claiming a carryover on the return where it belonged, you generally need to amend to recover it.

Carryovers Disappear at Death

Unused capital loss carryovers do not pass to an estate or to heirs. When the taxpayer dies, the carryover dies too. A surviving spouse can use the deceased spouse’s carryover on a joint return filed for the year of death, but any portion attributable to the deceased spouse is gone after that year.

For assets held jointly, the carryover is typically split evenly between spouses; the survivor keeps their half and loses the other. If one spouse alone owned the asset that generated the loss, the entire remaining carryover belongs to that spouse and vanishes if they die first. Large carryover balances are worth reviewing during estate planning, including whether to accelerate some gain recognition to absorb the losses while they can still be used.

The Wash Sale Rule

You can’t sell a security at a loss and immediately buy it back to lock in the tax benefit. The wash sale rule disallows the loss if you purchase a “substantially identical” security within a 61-day window centered on the sale: the 30 days before, the day of the sale, and the 30 days after.⁵ The window starts running before the sale, which surprises investors who buy first and then sell.

A disallowed loss is not permanently destroyed. It is added to the cost basis of the replacement shares, deferring the benefit until you sell those replacement shares in a clean transaction.⁶ Sell for a $5,000 loss and buy the same stock back two weeks later at $10,000, and your basis in the replacement shares becomes $15,000.

“Substantially identical” isn’t precisely defined. Repurchasing the exact stock or bond clearly triggers the rule. Buying a competitor in the same industry generally does not. Index funds sit in a gray zone: selling one S&P 500 fund and buying another provider’s S&P 500 fund could be treated as substantially identical because the holdings are the same. Switching to a fund tracking a different index is the safer move.

Cryptocurrency and Digital Assets

The wash sale statute applies only to “stock or securities.” The IRS classifies cryptocurrency and other digital assets as property, not securities, so the wash sale rule currently doesn’t apply to them.⁵ As of 2026, you can sell Bitcoin at a loss and repurchase it the next day while still claiming the loss. Legislative proposals have aimed to extend the rule to digital assets, so verify current law before relying on this.

The Extra Benefit for Higher Earners

Taxpayers above certain income thresholds owe an additional 3.8% net investment income tax on the lesser of their net investment income or the amount by which modified AGI exceeds $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately).⁷ These thresholds are not indexed for inflation.

Because capital losses reduce net investment income, they also reduce or eliminate this surtax. A loss that cancels a gain saves you the capital gains tax on that gain and the 3.8% surtax on it as well. For anyone above these income thresholds, the effective savings from harvesting losses run higher than the headline rates suggest.

Getting the Numbers Right

Every offset calculation starts with cost basis. For stocks and mutual funds, basis is generally the purchase price plus commissions or transaction fees. Brokerages report basis to the IRS on Form 1099-B for shares acquired after specific dates, but the reported figures are not always correct, particularly for shares acquired through reinvested dividends, splits, or corporate reorganizations. Check your 1099-B against your own records before filing.

If a stock or bond becomes completely worthless, you can claim the loss without an actual sale. Worthless securities are treated as sold on the last day of the tax year in which they became worthless. That deemed sale date sets the holding period. Because proving the exact year of worthlessness can be difficult, the IRS gives you seven years from the original filing deadline (rather than the usual three) to amend a return and claim a worthless security deduction.⁶

Reporting Sales and Losses

Report every investment sale on Form 8949, which organizes transactions by holding period and by whether your broker reported basis to the IRS. Each line needs the asset description, acquisition date, sale date, proceeds, and cost basis. Totals from Form 8949 flow to Schedule D of Form 1040, where the netting happens.⁸

Timing runs off the trade date, not the settlement date. Sell a stock on December 31, 2026, and the loss lands in the 2026 tax year even though settlement happens in early January 2027. Tax software handles the Form 8949 and Schedule D math once you enter or import the transactions, but the output only reflects what you put in. Verify basis entries against your own records, especially for assets held across multiple brokerages or moved between accounts.

1
Internal Revenue Service. Topic No. 409, Capital Gains and Losses
2
Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
3
Internal Revenue Service. Mutual Funds (Costs, Distributions, etc.) 4
4
Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
5
Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
6
Internal Revenue Service. Publication 550, Investment Income and Expenses
7
Office of the Law Revision Counsel. 26 USC 1411 – Imposition of Tax
8
Internal Revenue Service. Instructions for Form 8949