Various types of losses can be deducted from your taxes under specific conditions, effectively reducing your taxable income. The deductibility often depends on the nature of the loss, your income level, and whether you itemize deductions.
Capital Losses
Capital losses occur when you sell an investment, such as stocks, bonds, or real estate, for less than you paid for it. These losses are one of the most common types of deductible losses for individuals.
How They Work:
- Offsetting Capital Gains: You can deduct your capital losses against any taxable capital gains you have realized in the same tax year. This means your investment gains are reduced by your investment losses. If you have capital losses carried forward from a prior year, you can also use them to offset current-year capital gains.
- Offsetting Ordinary Income: If your capital losses exceed your capital gains, you have a net capital loss. This net loss can then be used to offset a limited amount of your ordinary income (like wages or salaries). For most taxpayers, this limit is $3,000 per year ($1,500 if married filing separately).
- Carryover Provision: Any capital losses that exceed both your capital gains and the ordinary income limit can be carried forward indefinitely to future tax years. These carried-forward losses can then be used to offset future capital gains and, if applicable, ordinary income, following the same rules.
| Loss Type | Primary Offset Against | Annual Limit (Offsetting Ordinary Income) | Carryover |
|---|---|---|---|
| Capital Loss | Capital Gains, then Ordinary Income | $3,000 (or $1,500 MFS) | Yes |
For more detailed information on capital gains and losses, refer to IRS Publication 550, Investment Income and Expenses on IRS.gov.
Other Deductible Losses
Beyond capital losses, other types of losses may be deductible, though often with specific limitations and criteria.
Casualty and Theft Losses
Casualty losses result from the damage, destruction, or loss of property due to a sudden, unexpected, or unusual event (e.g., fires, floods, hurricanes, or vandalism). Theft losses arise from the illegal taking of your property.
- Limited Deductibility: Under current tax law (Tax Cuts and Jobs Act of 2017), personal casualty and theft losses are only deductible if they occurred in a federally declared disaster area.
- Reporting: You must generally itemize deductions on Schedule A (Form 1040) to claim these losses, and they are subject to certain thresholds (e.g., a $100 per-event reduction and a 10% adjusted gross income (AGI) limitation).
- Example: If your home in a federally declared disaster area was damaged by a tornado, you might be able to deduct a portion of the unreimbursed loss.
More information can be found in IRS Publication 547, Casualties, Disasters, and Thefts on IRS.gov.
Business Losses
If you own a business, any losses incurred from its operations can often be deducted.
- Net Operating Losses (NOLs): If your business's deductions exceed its income, resulting in an NOL, you may be able to carry these losses forward to offset future business income. Rules regarding NOL carrybacks and carryforwards have changed over time (e.g., changes under the CARES Act).
- Passive Activity Losses: Losses from "passive activities" (like rental activities or businesses in which you don't materially participate) are generally limited to the income from other passive activities. Unused passive losses can often be carried forward.
- Example: A start-up company might incur significant expenses in its first year, leading to an operating loss that can be used to offset income in future profitable years.
Refer to IRS Publication 535, Business Expenses for more information on business loss deductions on IRS.gov.
Gambling Losses
You can deduct gambling losses, but only up to the amount of your gambling winnings reported for the year.
- Limitation: This means your deduction for losses cannot exceed your reported winnings. For instance, if you win $1,000 but lose $2,000, you can only deduct $1,000 in losses.
- Itemized Deduction: To claim gambling losses, you must itemize deductions on Schedule A (Form 1040). It is crucial to keep accurate records of both winnings and losses.
- Example: If you win $500 playing poker but lose $700 on sports betting in the same year, you can only deduct $500 of your losses.
Worthless Securities and Bad Debts
- Worthless Securities: If stocks, bonds, or other securities become completely worthless, you might be able to claim a capital loss. The loss is generally treated as a capital loss from the sale or exchange of a capital asset on the last day of the tax year.
- Bad Debts: Non-business bad debts (e.g., a personal loan to a friend that you cannot collect) can be treated as a short-term capital loss. Business bad debts (e.g., uncollectible accounts receivable from your business) are fully deductible as ordinary losses.
Rental Property Losses
Losses generated by rental properties can often be deducted, though they are subject to passive activity loss rules.
- Active Participation Exception: For taxpayers who "actively participate" in their rental real estate activities, there's a special allowance to deduct up to $25,000 of losses against non-passive income. This allowance begins to phase out for taxpayers with modified adjusted gross income (MAGI) above $100,000 and is fully phased out at $150,000.
- Real Estate Professionals: If you qualify as a "real estate professional" (meeting specific hours and participation tests), your rental real estate activities are not considered passive, and you can deduct all losses without the passive activity limitations.
For specific details, consult IRS Publication 527, Residential Rental Property on IRS.gov.
Important Considerations:
- Itemizing vs. Standard Deduction: Many loss deductions, especially for individuals, require you to itemize deductions on Schedule A (Form 1040) rather than taking the standard deduction. You should choose the method that results in a lower tax liability.
- Record Keeping: Maintaining thorough and accurate records for all income and expenses, including losses, is crucial for substantiating any deductions you claim.
- Tax Law Changes: Tax laws are complex and can change frequently. The rules governing loss deductions can be intricate and may have specific income limitations, phase-outs, or carryover provisions. It is always advisable to consult with a qualified tax professional for personalized advice.
