Monday, December 18, 2006


The maximum deduction you can claim as a net capital loss on your federal Form 1040 is $3,000 - it has been $3,000 for almost forever. If you have more than $3,000 in net capital losses on Schedule D you can carry forward the excess to future tax returns until all the losses have been used up.

If the net capital loss on Line 16 of your 2006 Schedule D is $10,000 you can deduct $3,000 against other income on your 2006 Form 1040 and carryover $7,000 in losses to 2007. If you have $3,000 in net capital gains for 2007 you can use $6,000 of the carryover loss in 2007 and carry the remaining $1,000 forward to 2008.

New Jersey has different rules. The New Jersey state income tax is a “gross” tax. It does not permit losses in one category of income, such as net gains from disposition of property, to be applied against income from other categories, such as wages, pensions and annuities, and interest. New Jersey also does not permit excess losses in any category to be carried forward to future years. Capital losses can only be used to wipe out capital gains. Excess capital losses, or losses in any category of income, are lost.

Capital gains are taxed by New Jersey at the same rate as all other income. There is no special capital gains rate.

In the above example the $10,000 of net capital losses for 2006 will not be deductible on the NJ return, and cannot be carried forward. You would never receive any NJ state tax benefit for these losses. In 2007 you would pay NJ income tax on $3,000 of net capital gains at your normal NJ tax rate, probably 5.525%.

So what to do?

A New Jersey resident who finds himself faced with $10,000 in net capital losses in December of 2006 should do whatever possible to generate an additional $7,000 in capital gains before year end. At a 5.525% state tax rate this could save $387.00 in state income taxes. However, you will not realize this potential $387.00 savings on the 2006 return. The savings will come in a future tax year.

Generally when discussing capital gain and loss planning I remind taxpayers that the first criteria for evaluating any transaction should always be financial - taxes are second. However in this case it really does not matter.

If you have a stock or mutual fund investment that you could sell at a $7,000 gain, but you want to hold on to it because you think it will continue to grow, you can sell the investment today and buy it back tomorrow. The wash sale rules only apply to investment sales that result in a capital loss!

By claiming a gain on a stock or mutual fund, which will not be taxed because of excess capital losses, and buying it back you will automatically increase your basis in the investment at no cost to you, and reduce the taxable gain when it is sold at a profit in the future.

I should point out that investment losses can also be applied against capital gain dividends on the NJ-1040, just as they can on the federal Schedule D.

Any questions?



Unknown said...

In an effort to offset losses can you sell a stock or mutual fund and buy it back immediately?

Robert D Flach said...


The "wash sale" rule applied to sales that generate losses only.

I know of no reason why one cannot sell a stock or mutual fund shares for a profit on Monday and buy back the exact same number of shares of the exact same stock or mutual fund on Tuesday.

Of course the gain on Monday's sale would need to be reported on Schedule D as income.


Jack said...

You should only realize short-term capital gains with this approach. Long-term capital gains should be left alone.

The $3,000 capital loss is applied against ordinary income on the federal 1040, offsetting taxes of 25% or more. But long-term gains are taxed at 15%. It doesn't make sense to give up a 10% federal tax differential to save 5.525% on New Jersey taxes.