Tax Implications of Stock Trading

If you took some losses this year in the stock market do not fret, you might be able to deduct your losses. There are many important tax implications to consider when trading, including key definitions, and applications with capital gains/losses for both short-term and long-term assets. Here is what you need to know.

Realized Capital Losses

An important term to keep in mind is “realized” capital gains or losses. A stock only becomes “realized” when you sell it, not when it is purchased. Realized capital losses can be used to reduce your tax bill only if the asset sold was owned for investment purposes. By this definition this applies specifically to stock market losses.

Stock Market Losses

Stock market losses are reported on Form 8949 and Schedule D for your tax return. Losses are first used to offset capital gains of the same class. Short-term losses offset short-term gains and long-term losses offset long-term gains.

• Short-term gains come from the sale of property owned one year or less and are taxed at the taxpayer’s maximum tax rate.
• Long-term gains come from the sale of property owned more than one year and are taxed at 15% or 20% depending on your tax bracket. For taxpayers in the 10% or 15% tax bracket the capital gains tax rate is 0%. Long-term gains from stock sales by children under age 19 – under age 24 if they are students may not qualify for the 0% rate due to Kiddie Tax rules. (When these rules apply, the child’s gains may be taxed at the parents’ higher rates.)

Overall Net Losses

In the case of overall net losses, either one can be deducted from the other kind of gain. If there is no capital gain short-term or long-term to offset the net capital loss, then you can use the loss to offset ordinary income up to $3,000 per year ($1,500 if married filing separately) with the excess net capital loss carried forward to subsequent tax years indefinitely. If the losses are substantial it may take some time to fully deduct them due to the yearly deduction limit. For example: If I have a $7,000 net capital loss, I can deduct $3,000 in year 1, $3,000 in year 2, $1,000 in year 3.

Special circumstances: Stock that is deemed worthless due to bankruptcy, liquidation, or termination of business activities of a company, allow a total capital loss on the stock even though there is no sale date for the loss to be realized upon. They are deductible under section 165(a) in the year the securities become worthless. The taxpayer is responsible for determining when the stock is deemed worthless. Determination of worthlessness is generally upheld as when there is no reasonable possibility that the investors will receive anything of value. There are numerous exceptions and rules that apply to this circumstance. No deduction is permitted for downward fluctuations in the market value of the securities regardless of reason for downward valuation and no deduction is allowed for partial impairment.