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Turning Lemons into Lemonade: Making the Most of Your Capital Loss Carryovers. And Making Them Last.

Nobody enjoys taking a loss on an investment. After all, the common goal of investing is to protect and grow your wealth. Yet, as you know well, all investments carry certain risks, and realizing occasional losses on the path to growing a higher net worth is inevitable. 

The IRS does offer a benefit to investors who have experienced losses, and it comes in the form of capital loss carryovers - an often-overlooked part of the tax code that allows investors to reduce future income tax obligations by applying a capital gains loss against that income.

In this article, we’ll discuss capital loss carryovers, how they work, and the IRS rules that govern them.

Understanding Capital Loss Carryovers

A capital loss carryover is a tax-saving strategy that allows you to use capital losses incurred in previous years to offset capital gains in the current and future years. This powerful tool can help reduce your tax liability and potentially save you a significant amount of money in the long run. The beauty of capital loss carryovers is that they can act as a financial safety net when your investments don't perform as expected.

IRS Rules and Regulations

The IRS has a set of rules that regulate how capital loss carryovers work. First and foremost, losses must be classified as either short-term or long-term, depending on how long you hold the asset. Short-term losses can only offset short-term gains, and the same goes for long-term losses and gains. If you have more losses than gains in a given year, you can use up to $3,000 of excess losses to offset other income. Any remaining losses are carried forward to future years.

Let's Walk Through an Example

Let's say in 2021, you sold some stocks for a long-term capital loss of $10,000 and had no capital gains that year. According to IRS rules, you can use $3,000 of this loss to offset other income in 2021, reducing your taxable income. The remaining $7,000 is carried forward to the following year, 2022.

Now, in 2022, you have $5,000 in long-term capital gains. You can use the $7,000 carryover from 2021 to offset the entire $5,000 in gains. This not only wipes out your tax liability for those gains but also allows you to carry over the unused $2,000 loss to the next year.

How Long Can You Carry Over Losses?

Capital loss carryovers can be a long-term strategy. You can continue carrying over losses until they are fully used up. There's no expiration date. This means that if you have a significant capital loss from years ago, you can still use it to offset gains in the current year or any future year when you have gains to offset.

For example, that $2,000 loss you carried over from 2022 can be used to offset gains in 2023, 2024, and beyond until it's entirely exhausted. The flexibility of this system allows you to maximize your tax efficiency over the long haul, which is an essential aspect of smart financial planning.

Final Thoughts

Capital loss carryovers are a financial tool that many investors overlook. They provide a valuable opportunity to mitigate tax liabilities and optimize your investment strategy. By strategically managing your capital losses and gains, you can create a more tax-efficient portfolio and potentially save a substantial amount of money in the process.

As you continue to build your wealth through a range of investments, consider the potential benefits of capital loss carryovers. They serve as a powerful tool to enhance your financial well-being and help you reach your long-term financial goals.

Most states follow IRS guidelines with respect to utilizing capital losses to offset capital gains – however please check with your tax advisor to confirm the capital loss rules in your state of residence. 

Remember, the tax code can be complex, and individual circumstances vary. It's always a good idea to consult with a tax professional or financial advisor to make the most of your capital loss carryovers and develop a personalized tax strategy that aligns with your unique financial objectives. 

If you’d like to learn more about other tax-efficient investment tools, download our complimentary eBook, Real Estate Tax Deferral Strategies Utilizing the Delaware Statutory Trust

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Paul Getty

Paul Getty is a licensed real estate broker in the state of California and Texas and has been directly involved in commercial transactions totaling over $3 billion on assets throughout the United States. His experience spans all major asset classes including retail, office, multifamily, and student, and senior housing. Paul’s transaction experience includes buy and sell side representation, sourcing and structuring of debt and equity, workouts, and asset and property management. He has worked closely with nationally prominent real estate brokerage and investment organizations including Marcus Millichap, CB Richard Ellis, JP Morgan, and Morgan Stanley among others on the firm’s numerous transactions. Paul also maintains a broad network of active buyers and sellers of commercial real estate including lenders, institutions, family office managers, and high net worth individuals. Prior to founding First Guardian Group/FGG1031, Paul was a founder and CEO of Venture Navigation, a boutique investment banking firm specializing in structuring equity investments made by institutions and high net worth individuals. He possesses over 35 years of comprehensive worldwide business management experience in environments ranging from early phase start-ups to multi-billion-dollar corporations. His track record includes participation in IPOs and successful M&A activity that has resulted in investor returns of over $700M. Paul holds an MBA in Finance from the University of Michigan, graduating with honors, and a Bachelor’s Degree in Chemistry from Wayne State University. Paul Getty holds Series 22, 62, and 63 securities licenses and is a registered financial representative with LightPath Capital Inc, member FINRA /SIPC. Paul is a noted speaker, author, and actively lectures on investments, sales, and management related topics. He is author of The 12 Magic Slides, Regulation A+: How the JOBS Act Creates Opportunities for Entrepreneurs and Investors, and Tax Deferral Strategies Utilizing the Delaware Statutory Trust (DST), available on Amazon and other retail outlets.

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