Yesterday I wrote about the wash rule and donating stock, today I want to briefly discuss what you do in the case where you losses exceed your gains. You typically use Schedule D to record your capital gains and losses and in the event of a net loss, you are permitted to deduct up to $3,000 of that loss from your ordinary income this year. If you have losses in excess of $3,000, you can carry those forward based on a very straight forward schedule outlined in Publication 550.
If you take the time to read 550, it’s very long, you will quickly learn that treating the losses is actually quite simple. First, any amount in excess of the annual $3,000 limit can be pushed to the next year indefinitely and treated as though the loss were incurred that year. Second, the status of the loss will carry forward. A long term capital loss that is carried to the next year will be treated as a long term capital loss, this means it will be used to reduce long term capital gains before short term capital gains and before ordinary income. There are additional rules and conditions in the event the loss is greater than your ordinary income but you’ll have to use the worksheet to figure that all out.
In the event the stock becomes worthless, it’s treated slightly differently but not much differently. First, they treat it as though you sold the stock in the very last day of the year (this is used to figure whether it’s a short or long term capital loss). On Schedule D you have to mark the stock as worthless and keep records for at least 7 years. More on this in a FAQ answer on the IRS website.
So, if you made some bad decisions and the net effect was a drop in your assets, you can reduce your income by up to $3,000 and push the remainder to next year. Hopefully things work out better next year!
(Despite putting stock in the title, I believe these rules apply for any loss of a capital asset. Warning, your home and your car are not considered capital assets, they are considered personal-use assets by the IRS according to their website)