A reader writes in, asking:
“I just read your article on capital gains and losses. I understand that up to $3,000 of a net capital loss can be used to offset ordinary income in a year, and the rest is carried over to use in future years, but I am unsure of whether the carryover is short-term or long-term. For example, if I have the following for one year:
$ 4,000 in STCL
$ 6,000 in LTCL
$10,000 in losses
-$ 3,000 writeoff against ordinary income
$ 7,000 capital loss carryover
Is the $7,000 carryover considered a short-term or long-term capital loss? Or is it divided on a pro-rata basis, such that there would be a carryover of $2,800 STCL and $4,200 LTCL?”
For questions of this nature, it’s often helpful to look at the tax forms themselves, to see how the numbers flow from one line to the next (and from one form to the next). In this case, doing an example run through Schedule D, using the “Capital Loss Carryover Worksheet” from Schedule D’s instructions can give you a good idea of how this all works.
The short answer is that the $3,000 that is deducted from ordinary income comes first from STCLs to the extent possible, then from LTCLs. Then the remaining losses retain their character when carried over for the next year.
So, if the numbers in your example were a taxpayer’s numbers for 2013, when that taxpayer filled out his Schedule D for 2014, he would have a $1,000 STCL carryover ($4,000 STCL, minus the $3,000 that had been used in 2013 to offset ordinary income) and a $6,000 LTCL carryover.
Alternatively, if the taxpayer’s 2013 numbers were as follows:
$ 2,000 in STCL
$ 6,000 in LTCL
$8,000 in losses
-$ 3,000 writeoff
$ 5,000 capital loss carryover
The entire $2,000 of STCL would be used up for the deduction, and the capital loss carryover for 2014 would be considered entirely long-term capital loss.