Brokers & Accounts · Intermediate · 5 min

Offsetting losses as a concept

You can explain how realized losses reduce taxable gains, why some losses can only be used against certain gains, and what a wash sale is.

Losses count too

A losing trade hurts. But in most tax systems it is not only a loss: it can also reduce the tax you pay on your gains. That is why traders talk about offsetting losses.

The idea is simple. The details are not, and they differ from country to country. This lesson is not tax advice. It explains the principle and shows, with two countries as examples, the kind of limits you need to look up for yourself.

How offsetting works

The basic principle in most systems: tax is due on your net result. Realized gains and realized losses in a year are added up, and tax is calculated on what remains. As with gains, a loss usually counts only once it is realized by selling.

If your losses are larger than your gains, many systems let you keep the unused part for later. This is a loss carryforward: it reduces taxable gains in future years.

Most countries add limits. Two examples:

Germany: losses from capital may not be offset against other kinds of income, such as salary, but they reduce capital income in later years. Losses from selling shares may only be offset against gains from selling shares.
US: capital losses offset capital gains. If a net loss remains, up to 3,000 dollars a year, or 1,500 if married filing separately, can reduce other income. The rest is carried forward to later years.

Some countries also stop you from selling only to create a tax loss. In the US, a wash sale happens when you sell at a loss and buy substantially identical securities within 30 days before or after the sale. The IRS then disallows the loss for now and adds it to the cost of the new shares, so the deduction is postponed, not lost.

Taxable: 2,000

A fictional trader has realized gains of 3,000 and realized losses of 1,000 in the same year, all from selling shares.

Without offsetting, tax would be due on 3,000.
With offsetting, the 1,000 of losses reduce the gains, and tax is due on 2,000.

Under the German flat rate from the last lesson, that saves 263.75. The loss still cost 1,000. The tax rule only softens it.

Now suppose the loss had come from a different kind of investment, one that the country's rules keep in a separate group. Then it could not reduce the share gains, and tax would be due on the full 3,000. The loss would wait as a carryforward until a matching gain appears.

Common mistakes

Trading for tax reasons. A tax saving never turns a bad trade into a good one.
Assuming any loss offsets any gain. Many countries sort losses into groups.
Selling and buying back at once. In the US, this can trigger the wash sale rule.
Expecting a refund. Losses usually reduce tax on gains. Many systems do not pay out money for a net loss.
Losing track of carryforwards. Keep records of unused losses from earlier years.
Forgetting that rules change. Check the current rules for your country and year.

The takeaway

Realized losses usually reduce taxable gains, and unused ones can often be carried forward. Many countries limit which losses offset which gains.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the part of the gains that is still taxed.

Tap the chart.

The 1,000 of realized losses reduce the 3,000 of gains. Tax is due on the remaining 2,000.
2In Germany, a loss from selling shares can be offset against which gains?

Under § 20 EStG, losses from selling shares may only be offset against gains from selling shares. Unused losses carry forward.
3In the US, how much of a net capital loss can reduce other income each year?

The IRS caps it at 3,000 dollars a year. The rest is carried forward to later years.
4In the US, you sell a share at a loss and buy it back 10 days later. What happens to the loss?

Buying substantially identical securities within 30 days before or after the sale makes it a wash sale.

of 4 correct.