Capital Gains, Capital Losses, and Wash Sales
🙋♂️ What Is Capital Gains Tax
When you earn income, it is taxed differently depending on how it is earned…
Ordinary Income is income that you actively work for…
W-2 job
1099 independent contractor income
Capital Gains( & Losses) – Refer to income generated by investing your money(capital) into assets (stocks, bonds, real estate, etc.)
The tax authorities treat these forms of income differently….
Ordinary Income:
This income is taxed in the year it is earned.
The more money you earn, the more tax you pay.
Each time you move up into a higher ‘bracket’ you pay a higher % of income tax. You can learn more about tax brackets here.
The highest bracket of Federal Income tax is 37%
Capital Gains:
This income is only taxed in the year an asset is sold.
If you buy stocks, or real estate, they can appreciate in value with no tax consequences until you sell.
Short Term Capital Gains – If you buy and sell an asset within 1 year.
Tax rate is based on your personal income tax rate.
Long Term Capital Gains – If you buy and hold your asset for at least one year.
Tax rate between 0 – 20% depending on your total income.
Most tax payers end up paying between 15 – 20%.
- Higher earners also owe a 3.8% Net Investment Income Tax (NIIT) on capital gains once income passes $200,000 (single) or $250,000 (married). Unlike the brackets, those thresholds are not adjusted for inflation, so more people cross them each year.
For 2026, the long-term capital gains tax rates are…
🫤 Capital Losses & Recording Them
A capital loss occurs when you buy an asset and end up selling it for less than what you paid. Imagine buying Enron for $10,000 and selling it for $5,000 a year later. You now have a $5,000 Capital Loss.
Since capital gains are taxed differently, you cannot use your capital loss to offset earned income from W-2s and 1099s. You can use capital losses to offset other capital gains.
A Small exception – The IRS allows you to use up to $3,000 of net capital losses to offset ordinary income each year. The remainder continues carrying forward until you can use it.
For example, if you have $10,000 in long-term capital losses and $5,000 in long-term capital gains, you can completely offset the gains and still deduct $3,000 from ordinary income in the same year. The remaining $2,000 can be carried forward.
It is extremely important to record these losses on your tax return when they occur. Failure to do so means you won’t get to use them. And they can be extremely valuable. Discussed more below.
📈 Stock Sales & Wash Sales
This is one of the most common mistakes made by traders.
A wash sale occurs when an investor sells a security at a loss, then repurchases the same security, or a “substantially identical” security, within a short period of time, typically within 30 days before or after the sale date.
The IRS established the wash sale rule to prevent taxpayers from claiming a tax deduction for a capital loss on an investment they haven’t truly divested themselves from.
If you wish to record a loss for tax purposes (Also known as tax loss harvesting), you must sell the stock and wait 31 days to re-purchase. Otherwise, it doesn’t work.
How it works…
A wash sale occurs when you buy the same or a substantially identical security within a 61-day window: this includes the 30 days before and 30 days after the sale date. This time frame is designed to ensure that investors don’t temporarily sell off an investment to claim a tax loss while maintaining the same position in the investment.
The wash sale rule applies not only when you repurchase the exact same security but also if you buy a “substantially identical” security. This could include:
Shares of the same company.
Call options or contracts to purchase the same stock.
Shares of the same stock held in different accounts (for example, if you sell a stock in a brokerage account and buy it back in an IRA, this could still trigger a wash sale).
For mutual funds or ETFs, the wash sale rule applies if the repurchased security tracks the same index or is otherwise deemed substantially identical.
Loss Disallowed:
If the IRS determines that a wash sale has occurred, the capital loss from the sale is disallowed for tax deduction purposes. This means you can’t claim the loss on your tax return.
However, the disallowed loss is added to the cost basis of the newly purchased securities, effectively deferring the loss until you eventually sell the replacement securities.
🤔 Other Considerations
Retirement Accounts
It is important to remember that your retirement accounts are treated much differently than your normal brokerage accounts – they do not get the benefit of long term capital gains.
When you invest in a retirement account, the IRS gives you a highly tax advantaged account. You can buy and sell within the retirement account without paying taxes until you distribute the funds.
The flip side of this is that long term capital gains do not apply.
All Distributions From (Pre Tax) Retirement Account Are Subject To Ordinary Income Tax Rates!
Plan accordingly. For more on how these accounts are taxed, see our Retirement Accounts article.
🤔 Parting Thoughts
As always, thanks so much for reading! If you enjoy reading, please share these articles with anyone (subscribe here) that you feel might benefit.
If you have any additional questions, please reach out. We help individuals and businesses year-round with personal and business tax services.
Thanks,
– Taxman