Capital losses can offset ordinary income, but only up to $3,000 per year

When you sell an investment at a loss, you can use that loss to reduce your taxable ordinary income — but the IRS caps how much you can deduct each tax year. The limit is $3,000 for single filers and married filing jointly. Any loss beyond that $3,000 carries forward to future years, where the same $3,000 annual limit applies.

This matters because ordinary income (wages, self-employment income, interest, and some retirement distributions) is usually taxed at higher rates than long-term capital gains. Using a capital loss to offset ordinary income can save you real money, but only if you understand the order in which losses are applied and what happens to the excess.

Key Takeaways

  • You can deduct up to $3,000 of capital losses against ordinary income in a single tax year, whether you are single or married filing jointly.
  • Capital losses must first offset capital gains from the same year; only the net loss can then offset ordinary income.
  • Any capital loss that exceeds the $3,000 annual limit does not disappear — it rolls forward to the next tax year and the next, indefinitely.
  • Long-term capital losses (from assets held over one year) are more valuable than short-term losses because they can offset long-term gains at a lower tax rate.
  • Tax-loss harvesting — deliberately selling losing positions to capture losses — is a common strategy, but timing and wash-sale rules matter.

How losses are applied: gains first, then ordinary income

The IRS does not let you pick and choose which losses offset which income. The order is fixed. First, all capital losses offset capital gains from the same year. Only after that is done can you use any remaining loss against ordinary income, up to the $3,000 limit.

Example: You sell a stock at a $5,000 loss and a mutual fund at a $2,000 gain. Your net capital loss is $3,000. You can deduct the full $3,000 against ordinary income this year. But if you had a $5,000 loss and a $4,000 gain, your net loss would be $1,000, and you could deduct only that $1,000 against ordinary income.

This structure means that in years when you have both gains and losses, the losses are most valuable if they are larger than the gains. If your losses are smaller than your gains, you will owe tax on the net gain and have no loss left to offset ordinary income.

What happens to losses you cannot use this year

Capital losses that exceed the $3,000 annual limit do not expire. They carry forward indefinitely to future tax years, where they continue to be subject to the same $3,000 annual limit. This means a large loss in one year can reduce your taxable income over many years.

Example: You realize a $10,000 capital loss in 2024. You can deduct $3,000 against ordinary income in 2024. The remaining $7,000 carries to 2025, where you can deduct another $3,000. The remaining $4,000 carries to 2026, and so on, until the loss is fully used or you die (at which point unused losses are generally lost).

When you file your tax return, you report the current year's losses and any carryforwards on Schedule D (Capital Gains and Losses). The IRS tracks these carryforwards, but you should keep your own records as well, especially if you have losses spanning multiple years.

Long-term versus short-term losses: which is more valuable

Capital losses are divided into two categories based on how long you held the asset. If you held it for more than one year, the loss is long-term. If one year or less, it is short-term. This distinction matters because of how they are applied.

Short-term losses offset short-term gains first, and long-term losses offset long-term gains first. Only after losses and gains within each category are netted do you combine the two categories. In practice, this means long-term losses are often more valuable: they can offset long-term gains (which are taxed at lower rates) before being used against ordinary income.

If you are planning to harvest losses deliberately, consider whether you have long-term or short-term gains to offset. A long-term loss can save you more tax if it offsets a long-term gain, because long-term gains are taxed at 0%, 15%, or 20% depending on income, while ordinary income can be taxed at rates up to 37%.

Tax-loss harvesting and the wash-sale rule

Many investors deliberately sell losing positions to capture the loss for tax purposes — a strategy called tax-loss harvesting. This is legal, but the IRS has a rule designed to prevent you from getting a tax deduction and keeping the investment at the same time.

The wash-sale rule says you cannot deduct a loss if you buy the same or a substantially identical security within 30 days before or after the sale. If you do, the loss is disallowed, and the cost basis of the new purchase is increased by the disallowed loss amount. The 30-day window is strict: it runs from 30 days before the sale to 30 days after.

To harvest a loss and stay invested, you can buy a similar but not identical security. For example, if you sell a losing position in one S&P 500 index fund, you can when ready buy a different S&P 500 index fund or an ETF tracking the same index. The IRS considers these substantially different, so the wash-sale rule does not explore. After 30 days, you can switch back to your original fund if you want.

When harvesting losses makes sense

Tax-loss harvesting is most valuable when you have realized capital gains elsewhere in your portfolio or in other years. If you have no gains to offset and no ordinary income to reduce (because your income is very low), harvesting a loss now means carrying it forward to a year when you might benefit from it — which could be years away.

It also makes sense when you are in a high tax bracket. A $3,000 loss offsets $3,000 of ordinary income, which saves you tax at your marginal rate. If you are in the 37% federal bracket, that is $1,110 in federal tax saved. If you are in the 12% bracket, it is $360. The higher your bracket, the more valuable the loss.

Harvesting is less useful if you are near the end of your life or if you expect your income to drop significantly in future years. Unused losses are lost when you die, and losses carried forward to years when your income is lower save you less tax.

State and local tax considerations

Capital losses reduce your federal taxable income, but most states that have an income tax also allow you to deduct capital losses. However, the rules vary by state. Some states follow the federal $3,000 limit; others allow larger deductions or have different rules for long-term versus short-term losses.

A few states (including California and New York) have special rules for high-income earners or specific types of capital gains. If you live in a state with income tax, check your state's rules or consult a tax professional to understand how your capital losses affect your state return.

Frequently Asked Questions

Can I use a capital loss to offset capital gains from a previous year?

No. Capital losses can only offset capital gains from the same tax year. If you have a loss this year and a gain last year, you cannot go back and amend your prior return to use the loss. However, if you have a loss this year that exceeds your gains this year, the excess can offset ordinary income (up to $3,000) or carry forward to future years.

What if I have more than $3,000 in losses and no capital gains?

You can deduct $3,000 of the loss against ordinary income this year. The remaining loss carries forward to next year, where it is subject to the same $3,000 limit. This process continues until the loss is fully used or you pass away. Keep records of the carryforward amount so you can claim it in future years.

Does the wash-sale rule explore to cryptocurrency or options?

Yes. The wash-sale rule applies to all securities, including cryptocurrency and options. If you sell a cryptocurrency at a loss and buy the same cryptocurrency within 30 days, the loss is disallowed. For options, the rule is more complex because options on the same underlying security may be considered substantially identical, so consult a tax professional if you trade options.

Can I harvest losses in a retirement account like a 401(k) or IRA?

No. Retirement accounts are tax-deferred, so losses and gains inside them do not generate taxable events and cannot be harvested. You can only harvest losses in taxable brokerage accounts. However, if you withdraw money from a retirement account at a loss, you cannot deduct that loss.

If I die with unused capital losses, what happens to them?

Unused capital losses are generally lost when you die. They do not transfer to your heirs or your estate. This is one reason to consider harvesting losses in years when you are in a high tax bracket or have significant gains, rather than carrying them forward indefinitely.