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I saw a Dave R video where a woman said she was advised by an accountant to have brokerage income/gains to "utilize" (the woman's words from her accountant) $316,000 in capital losses. I was under the impression that we could only claim up to $3,000 in capital losses, but this sounds like there's a way to claim more or spread them over a period of time.

If we have a capital loss of say $5,000, is there a way to spread this or claim it against income above the $3,000 limit?

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Yes, that's perfectly legit. Capital losses are anti-income, and are tax deductible in principle... But there are some artificial limits, and the accountant is advising how to avoid those. Nice thing, this deductibility bypasses the annoying $12,000 standard deduction, so you can deduct even if you don't itemize.

Capital losses can offset capital gains

Anytime you have capital gains and capital losses, you can let them cancel each other out. That way, you don't have to pay capital gains tax on the gains that were wiped out by other capital losses.

This means that capital losses mean you are not taxed the typically 10-15% for those capital gains.

You can write off $3000 a year in any case

Your first $3000 of capital losses can always be deducted (from regular income), even if you had no capital gains at all. This is nice, because it offsets regular income at 22 to 32%, but that's also why it's capped.

You can carryforward capital losses to future years

You can take your $3000, and offset your capital gains... And if you still have capital losses left over, you can roll those over to the next tax year. This is important, because it means past losses can offset future gains. Let's see how this works.

  • 2008: you take a $200,000 capital loss. You have $0 capital gains. You take $3000 against regular income.
    • Then you carryforward $197,000 of capital losses to the next year.
  • 2009: you have $100,000 in capital gains. The $197,000 carried from last year cancels out all $100,000 of capital gains, so you pay no tax on that. You still have $97,000 of capital losses left over, so you take the $3000.
    • You carry forward $94,000 of losses.
  • 2010: you have $5000 of capital losses. This adds to your carryforward, totaling $99,000. You take your $3000.
    • You carry forward $96,000.
  • 2011: you have $100,000 of capital gains. Your losses carred forward cancel out $96,000 of it. You pay capital gains tax on the remaining $4000.
    • You have no more capital losses to carry forward.

Needless to say, you’ll take more than a lifetime to take $316,000 of capital losses at $3000 a year. The accountant is saying It'd be a really good idea to arrange your portfolio and compensation so you get a lot of capital gains income, since it'll be tax-free (or to be more precise, you already paid the taxes on it when you were unable to deduct the capital losses in the year they occurred). The accountant is saying "If you're not into investing, now would be a very good time to change that".

But investing doesn't work! I never want to do that again...

Endowment manager here. Nonsense. Competent investing absolutely does work, and is the engine which powers university endowments with 100% reliability. It funds sports programs, professorships, free clinics, and soup kitchens. Endowments are "watched like a hawk" by University boards, many of whom are the smartest investment bankers in the world. There is a conservative gold standard on how to invest endowments, and it works. (Hint: Bogle was right).

The problem is, what your friends were doing before was incompetent investing. I spent a winter day-trading. I broke even, but in that time the S&P 500 gained 8%. So I left 8% on the table (vs just buying an S&P index fund). Daytrading is too quick to benefit from market strength, so it's a zero sum game. When a pro acting on inside information gains in day-trading, someone must lose -- that's you, the novice. That's the trouble - there's only one market, so you're at the same table with the sharpest pros in the world.

Whereas when you invest long-term, in highly diversified investments (i.e. The whole market via mutual finds like VTI), now you are letting the inherent strength of the economy do your earning for you. This is the secret to endowments. Of course you must still have a pair of these, because volatility is a real thing - markets go up and down, as you well know... And you need the nerve to not panic when downturns happen. The golden rule is

Buy low, sell high

Not "panic at the first scary report on the news". Remember, a downturn means Wall Street is having a BOGO sale. Buy low!

But if your friends can gain some proper skills and regain their confidence in investing, they can collect their capital gains in a few years.

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  • This is a great answer and I didnt know about the carry over rule. Thanks for the indepth answer!!!
    – Ms Jackson
    Feb 14 '20 at 15:00
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You can only offset $3,000 of ordinary income with capital losses for the year (unless you're a full-time trader). The accountant's advice is that they should shift money to a brokerage account to generate capital gains which can be offset entirely by the carried over losses.

As Dave points out, it is good tax advice, but might not be practical in their situation since they have low income and getting into trading might not be wise for someone that just squandered a huge sum of money.

If they keep the irresponsible party out of it and have funds available to invest, then they should invest (not day-trade) to not waste the losses.

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  • Can't agree.. Competent investing works; endowments rely on this entirely. Investing like an endowment is always sensible in the long term. If that wasn't true, endowments wouldn't work. They definitely do work. Feb 13 '20 at 20:06
  • @Harper-ReinstateMonica The point in this case is that the individual seems incapable of competent investing (blew 316k in 6 weeks of trading) and they don't seem to have excess to invest due to low income. But I agree that if they could invest responsibly they should do so, edited to clarify that.
    – Hart CO
    Feb 13 '20 at 20:34
  • Well done: plus one! ------ Okay, that's my new catch phrase! Feb 13 '20 at 20:36
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The annual capital loss deduction is $3,000. In order to utilize a larger loss you must:

  • Harvest capital gains that can then be offset

  • Be a full time trader (in size and volume) who has been granted Trader Tax Status by the IRS (hardly the type of person that would be looking to Dave R for advice).

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The capital loss can be carried-over as many years as the investor lives. So the capital loss is an asset. But the capital loss only offsets $3000 per year in income but will offset any amount of capital gains up to the amount of the capital loss.

Now say that the investor, who has a carryover capital loss, is making 1.5% annually in three-month Treasury Bills which is riskless income. What they need instead is 1.5% in riskless capital gains.

For one example, buy a gold position, hedge the gold with a year-ending sell-side futures contract, close out the gold position and the futures position at the end of the year, and the net result is a capital gain in the amount of the contango in the futures contract.

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