What are capital gains and how do passive losses work?

When investing in stocks, mutual funds, and other capital assets, it’s important to understand the following…

1. Almost everything you own and use for personal purposes, pleasure or investment is a capital asset. Capital assets include your home, household furnishings, and stocks and bonds that you hold as investments.

2. A capital gain or loss is the difference between your basis of an asset and the amount you receive when you sell it. Your basis is usually what you paid for the asset.

3. You must include all capital gains in your income.

4. You may deduct capital losses on the sale of investment property. You cannot deduct losses on the sale of personal-use property.

5. Capital gains and losses are long-term or short-term, depending on how long you hold on to the property. If you hold the property more than one year, your capital gain or loss is long-term. If you hold it one year or less, the gain or loss is short-term.

6. If your long-term gains exceed your long-term losses, the difference between the two is a net long-term capital gain. If your net long-term capital gain is more than your net short-term capital loss, you have a 'net capital gain.’ 

7. The tax rates that apply to net capital gains are generally lower than the tax rates that apply to other types of income. The maximum capital gains rate for most people in 2024 is 20%. For lower-income individuals, the rate may be 0% on some or all their net capital gains. 

8. If your capital losses are greater than your capital gains, you can deduct the difference between the two on your tax return. The annual limit on this deduction is $3,000, or $1,500 if you are married filing separately.

9. If your total net capital loss is more than the above limits you can deduct, you have a passive loss, which is then carried over to the next tax year. You’d then use that loss to offset net capital gains in that next tax year, or you’d take another $3,000 deduction. This occurs in each subsequent year until all losses are used up.

​Updated 1/22/2024