Short-Term vs. Long-Term

• Congress encourages investors to invest for the long term by charging higher taxes on shorter term investments. If you purchase an asset and hold it for a year or less before selling, you may be charged a higher tax rate of up to your ordinary income tax rate. However, if you hold it for longer than one year, you may be able to pay a more favorable long-term capital gains rate. As of early 2011, that more favorable long-term tax rate was between 5 percent and 20 percent, depending on your income level.
  
  

Capital Losses and Capital Gains

• If you sell something at a loss, you can typically deduct the loss against an unlimited amount of capital gains. You can match the losses against the gains, dollar for dollar, until you have canceled out your capital gains tax liability for the year. Many investors will deliberately sell losing holdings in order to cancel out expected capital gains tax liability.
  
  

Capital Losses and Income

• If you have more losses in a given year than gains, you can deduct up to $3,000 per year against your income, or up to $1,500 if you are married and file separately. This may reduce your overall income tax liability for the year. The amount of the excess loss that can be claimed is the lesser of $3,000 ($1,500 for those who are married and file separately) or the total net capital losses as shown on line 16 of the Form 1040 Schedule D. If you have more than $3,000 in losses after you have canceled out all capital gains, you can carry forward any excess to future years.
  
  

Carrying Losses Forward - An Example

• If you have $5,000 in capital gains and $15,000 in capital losses this year, you can cancel out all your capital gains. You have $10,000 in capital losses left over. You can carry them forward to cancel out capital gains in future years. If you have no capital gains, you can deduct another $3,000 against your income taxes the following year, carrying forward $7,000 in capital losses to the year after that.
  
  

• If you sell a security or asset and claim a capital loss, you cannot purchase that security or a substantially similar security for at least 30 days. For example, if you bought stock in Ford Motor Company and sold it at a loss, you cannot repurchase that stock for 30 days. However, you can buy stock in a similar company, or you can buy preferred stock and sell the common shares. You can also purchase options on Ford stock, or purchase a mutual fund that owns Ford and other car companies.