Capital Loss Limitations

Capital loss limitations refer to the restrictions imposed by tax authorities on how much an investor can deduct from their capital losses against their ordinary income. Typically, if an individual has more capital losses than gains in a year, they can only use a small, fixed amount of that excess loss to reduce their ordinary taxable income.

Any remaining loss must be carried forward to future tax years. This limitation prevents investors from using market losses to entirely eliminate their tax burden on wages or other income sources.

For traders, these limitations can be a significant financial hurdle, which is why the Section 475 election is often used to bypass these caps by reclassifying trading activity.