Personal Finance & Money Asked on December 10, 2020
Regarding tax-loss harvesting in the United States, https://www.moneyunder30.com/profit-from-tax-loss-harvesting (mirror) mentions some priorities between short-term capital gains and long-term capital gains when tax-loss harvesting short-term capital losses, but doesn’t indicate what the priority for income is:
Long-term losses are first applied against long-term gains, and then against short-term gains. Meanwhile, short-term losses are applied first to short-term gains. This sequence takes place because long-term capital gains are taxed at a lower tax rate than short-term capital gains.
When tax-loss harvesting short-term capital losses in the United States and assuming I don’t have short-term capital gains, but have long-term capital gains, can these losses be deducted against my ordinary income or does it first have to be deducted against my long-term capital gains (up to 3000 USD in 2020 + leftover losses can be carried forward to future tax years)?
Example for year 2020:
- short-term capital losses = 3000 USD
- long-term capital losses = 0 USD
- short-term capital gains = 0 USD
- long-term capital gains = 2000 USD
- income (W2) = 40000 USD
For the year 2020, can I deduct 3000 USD of short-term capital losses solely toward my income? Or do have to first deduct 2000 USD of short-term capital losses toward my long-term capital gains, then deduct the remaining 1000 USD of short-term capital losses toward my income?
Reason to prefer deducting 3000 USD of short-term capital losses solely toward my income: long-term capital gains are taxed at a lower rate than my income, hence deducting income is financially preferable to deducting long-term capital gains.
When harvesting tax losses, short-term capital losses must be deducted against the following, in that order:
Subsequently, in the example the 3000 USD of short-term capital losses must first be deducted toward all the 2000 USD of long-term capital gains (since there is no short-term capital gains), then the remaining 1000 USD of short-term capital losses must be deducted toward my income.
You should first offset losses for a given type of holding against the first gains of the same type (for example, long-term gains against long-term losses). If there are not enough long-term gains to offset all of the long-term losses, the balance of long-term losses can go toward offsetting short-term gains, and vice versa.
Maybe you had a terrible year and still have losses that did not offset gains. Left-over investment losses up to $3,000 can be deducted against other income in a given tax year with the rest being carried over to subsequent years.
Correct answer by Franck Dernoncourt on December 10, 2020
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