Section 12.3: Capital Losses, Carry-Forwards, & Wash Sales
Offsetting Capital Gains with Capital Losses
Using Excess Losses to Reduce Ordinary Income
Carry-Forward Losses
Wash Sales
Offsetting Capital Gains with Capital Losses:
Capital losses may be used to offset capital gains on a dollar-for-dollar basis.
Example:
If you have $10,000 in capital gains and $7,000 in capital losses,
then:10,000 − 7,000= 3,000 net capital gain
✅ You only pay taxes on $3,000 of gains.
Using Excess Losses to Reduce Ordinary Income:
If your losses exceed your gains, you can use up to $3,000 of those extra losses to reduce ordinary income for that year.
This helps lower your taxable income.
Example:
Capital gains = $24,000
Capital losses = $32,00032,000 − 24,000 = 8,000 net loss
You can:
Use $3,000 of that loss to reduce ordinary income this year.
Carry forward the remaining $5,000 to future years.
Carry-Forward Losses:
Unused capital losses (beyond the $3,000 limit) may be carried forward indefinitely.
There is no time limit on how long you can use them.
These are called carry-forward losses.
✅ You can continue using them year after year until fully used.
Wash Sales:
A wash sale occurs when an investor sells a security at a loss and then repurchases the same or substantially identical security within 30 days before or after the sale.
Key details:
The loss cannot be used for tax purposes if the sale is a wash sale.
The rule applies to both:
Long positions
Short positions
Applies to:
The same security
Substantially identical securities (like options or convertibles)
⚠️ A wash sale is not illegal, but claiming the loss on taxes is.
Gains & Losses
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Gains & Losses 〰️
Wash Sale Example 1:
Timeline:
Oct 21, 2015: Buy 1,000 shares of XYZ @ $30
Nov 17, 2016: Sell 1,000 shares of XYZ @ $28 → establishes a $2,000 loss
Nov 23, 2016: Buy 1,000 shares of XYZ @ $27
Since the repurchase occurred within 30 days, the IRS classifies this as a wash sale.
🚫 The $2,000 loss cannot be used for tax deduction.
Wash Sale Example 2 (Substantially Identical Securities):
Scenario:
Customer sells 500 shares of XYZ common stock at a loss.
Three days later, buys 3 XYZ call options (each = 100 shares).
Because call options give the right to buy the same stock, they are considered substantially identical to the stock itself.
✅ The wash sale applies to the 300 shares represented by the 3 call options.
✅ The investor can still claim losses on the remaining 200 shares (not repurchased).
Summary Chart
Rule / Key Point / Tax Impact
Capital Loss Offset / Losses offset gains $1 for $1 / Reduces capital gains tax
Excess Loss Deduction / Up to $3,000 of excess losses reduce ordinary income / Reduces income tax
Carry-Forward Losses / Unused losses carried forward indefinitely / Future tax benefit
Wash Sale Rule / Rebuy same or substantially identical security within 30 days / Loss disallowed
Substantially Identical / Options or convertibles tied to same stock / Treated as same security
✺ Review questions ✺
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If a reasonable person would interpret it as advice to act on a security, investment class, or strategy, it’s a recommendation — regardless of the speaker’s intent.
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To ensure that a broker understands a customer’s financial status, circumstances, and objectives so that all recommendations are suitable.
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A. Explaining what a limit order is
B. Suggesting a buy limit order on a specific stock
Answer:
B. Suggesting a buy limit order on a specific stock. -
Financial status, non-financial circumstances, and investment objectives.
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Tax-free income.
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CDs, money market funds, fixed annuities, or government securities.
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Technology stocks or sector funds.
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Exchange-listed securities, mutual funds, or publicly traded REITs.
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Speculation.
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Because they must have a reasonable basis to believe the recommendation is suitable for that specific customer.