Selling stock at a loss lowers your taxes in three stacked ways: the loss first cancels any capital gains you had that year dollar for dollar, then up to $3,000 of anything left over comes off your ordinary income like wages or interest, and whatever still remains carries forward to future tax years with no expiration.1Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses That is the whole framework. The details below decide how much tax you actually save and where the traps are.
How Losses Cancel Out Gains
The IRS separates every sale into short-term (held one year or less) and long-term (held longer than a year) before doing anything else.2Office of the Law Revision Counsel. 26 USC 1222 – Other Terms Relating to Capital Gains and Losses Short-term gains are taxed at your ordinary income rate, which runs as high as 37%. Long-term gains get the preferential capital gains rates of 0%, 15%, or 20%. That gap is why the netting order matters: a short-term loss killing a short-term gain saves you tax at your top ordinary rate, while a long-term loss killing a long-term gain saves you tax at the lower capital gains rate.
The math runs in stages. All your short-term gains and losses for the year get combined into one net short-term figure. All your long-term gains and losses get combined the same way. If both categories come out positive, you owe tax on each at its own rate. If both come out negative, they add together into a single net capital loss.
The more common situation is a gain in one category and a loss in the other. When that happens, the loss crosses over. Say you finish the year with $8,000 in net short-term gains and $12,000 in net long-term losses. The first $8,000 of the long-term losses erases the short-term gains entirely, leaving $4,000 of net capital loss to apply against ordinary income or carry forward.1Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
One piece that surprises people: capital gain distributions from mutual funds and ETFs count as capital gains in this calculation. Funds usually classify these distributions as long-term, and your realized stock losses offset them the same as any other gain. You can benefit from harvesting losses even in a year you never sold a winning position.
The $3,000 Deduction Against Ordinary Income
If your total capital losses exceed your total capital gains, the excess reduces wages, interest, and other ordinary income. The annual limit is $3,000 for single filers and married couples filing jointly, and $1,500 for married filing separately.3Internal Revenue Service. Topic No. 409, Capital Gains and Losses Earn $75,000 in wages with $3,000 of net capital losses beyond your gains, and you’re taxed on $72,000.
The $3,000 cap has held since 1978 and is not adjusted for inflation. A taxpayer in the 24% bracket saves $720 a year from this deduction; someone in the 37% bracket saves $1,110. Modest per year, but it compounds over a long carryover.
Carrying the Rest Forward
Anything above the $3,000 ordinary-income deduction rolls into the next tax year. There is no expiration; you can carry losses forward for as many years as it takes to burn through them.4Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers The carryover keeps its character too. A net short-term loss carries forward as short-term; a net long-term loss stays long-term, and each is fed into next year’s netting process in its own bucket.
Here is how it looks in practice. You sell stock at a $25,000 loss with no gains that year. You deduct $3,000 against ordinary income and carry $22,000 forward. Next year you realize $10,000 in gains. The carryover wipes those gains out, another $3,000 comes off ordinary income, and $9,000 rolls into year three. The cycle repeats until the balance is zero.
Report the carryover on every return, even in years with no new investment activity. The chain of Schedule Ds documenting the balance is what supports the amount you eventually claim, and the IRS can push back if the trail has gaps. Keep the records.
Carryovers Do Not Survive Death
Unused carryovers die with the taxpayer. Losses can be used on the decedent’s final return, subject to the same $3,000 cap against ordinary income and unlimited offset against that year’s gains. A surviving spouse filing a joint return for the year of death can apply the full loss against the couple’s combined income for that year.5Internal Revenue Service. Publication 559, Survivors, Executors, and Administrators Anything left after that final return is permanently gone. It does not pass to heirs, and the estate cannot carry it forward.6Internal Revenue Service. IRS Resource Guide – Decedents and Related Issues Someone sitting on a large carryover who also holds appreciated positions may want to realize gains during life to soak up the losses, rather than lose both the carryover and the value of the stepped-up basis.
The Wash Sale Rule Can Erase Your Deduction
The wash sale rule stops you from claiming a loss when you effectively keep the same investment. If you sell a security at a loss and buy back the same or a “substantially identical” security within 30 days before or 30 days after the sale, the loss is disallowed for that tax year.7Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities The restricted window is 61 days total: the 30 before, the sale date itself, and the 30 after.
A disallowed loss usually is not permanently lost. The amount gets added to the cost basis of the replacement shares, so you recognize it when you eventually sell those shares outside the 61-day window. Buy replacement shares at $40 with a disallowed $5-per-share loss, and your adjusted basis becomes $45.7Office of the Law Revision Counsel. 26 USC 1091 – Loss From Wash Sales of Stock or Securities
What “Substantially Identical” Means
The IRS gives no exhaustive definition, and the answer depends on the facts. Stocks of one company are generally not substantially identical to stocks of another, so selling one tech stock at a loss and buying a different tech stock does not trigger a wash sale. Bonds or preferred stock of a company are not ordinarily identical to the same company’s common stock, but a convertible security can be treated as substantially identical to the common stock when it trades close to the conversion ratio and moves with the same price signals.8Internal Revenue Service. Publication 550, Investment Income and Expenses Index funds are grayer territory; selling one S&P 500 fund and buying a near-identical S&P 500 fund from another provider is risky, and the IRS has not issued definitive guidance on that scenario.
Wash Sales Across Accounts and Into an IRA
The rule applies across every account you have, not just within one brokerage. Sell a stock at a loss in one taxable account and buy it back in a different taxable account inside the window, and the wash sale still triggers. Your brokerage only tracks wash sales within its own walls and within the same security, so anything crossing accounts is on you to monitor.
The worst version involves retirement accounts. If you sell a stock at a loss in a taxable account and buy the same stock inside your IRA or Roth IRA within the 61-day window, the wash sale rule still fires. The disallowed loss does not get added to the IRA’s cost basis, because IRAs do not track basis that way. The loss is permanently gone.9Internal Revenue Service. Revenue Ruling 2008-5 This is the single most expensive wash sale mistake an individual investor can make.
Worthless Stock and Small Business Stock
When a stock becomes completely worthless, you don’t have to sell to claim the loss. The tax code treats worthless securities as if sold for $0 on the last day of the taxable year in which they became worthless, and the resulting loss is short-term or long-term based on how long you held through that day.10Office of the Law Revision Counsel. 26 USC 165 – Losses
The hard part is proving the security actually became worthless in the year you claim it. A stock trading at a penny is not worthless; it needs no liquidation value and no reasonable prospect of recovery. A steep decline in market price, however brutal, does not qualify.11eCFR. 26 CFR 1.165-5 – Worthless Securities If you’re unsure, sell the shares for whatever tiny amount you can get. The sale creates a clean realized loss without the burden of proving worthlessness.
Losses on qualifying small business stock get better treatment. Stock bought directly from a small domestic corporation that met certain capitalization requirements at issuance can produce an ordinary loss rather than a capital loss. That matters because ordinary losses are not stuck under the $3,000 annual cap; the limit is $50,000 per year, or $100,000 for married couples filing jointly.12Office of the Law Revision Counsel. 26 USC 1244 – Losses on Small Business Stock Not every small business stock qualifies. The requirements are specific, and the stock must have been issued for money or property, not services.
How to Report the Loss on Your Return
Your brokerage sends Form 1099-B listing every sale of securities for the year, with cost basis, sale proceeds, and short-term or long-term classification for each one.13Internal Revenue Service. Instructions for Form 1099-B Those individual transactions go on IRS Form 8949, with short-term and long-term sales in separate parts.
Totals from Form 8949 flow to Schedule D of your Form 1040, and that is where the netting actually happens.14Internal Revenue Service. Instructions for Schedule D (Form 1040) Schedule D combines your short-term results, combines your long-term results, cross-nets between categories, applies the $3,000 ordinary income deduction if you have a net loss, and calculates the carryover to next year. When your brokerage reported cost basis to the IRS and the 1099-B numbers are correct, some transactions can go straight to Schedule D without filling out Form 8949 for each one.
If the brokerage did not report cost basis, which happens with older shares or transferred accounts, you have to reconstruct it from your own records. Original purchase confirmations, reinvestment statements, and records of stock splits or corporate actions all matter. If you cannot substantiate a basis and the IRS audits, the agency can treat basis as zero, which turns your entire sale proceeds into gain.