Can Capital Losses Offset Ordinary Income?

Three thousand dollars — that’s the annual ceiling on capital losses offsetting ordinary income, unchanged since 1978 and unindexed out of spite, apparently. The full netting system matters more than the famous number, especially for property sellers.

The netting order

Losses first offset gains of their own flavor (short against short, long against long), then cross over, then — whatever survives — up to $3,000 against wages and other ordinary income, with the remainder carried forward indefinitely. A $150K stock-loss year against no gains helps ordinary income by $3K annually for decades… unless a gain shows up to absorb it. Which is the planning insight: loss carryforwards are gain-vouchers waiting for a matching sale year.

The real estate exceptions

Two upgrades property investors get. Section 1231: losses on the sale of business/rental real estate held over a year are ordinary losses — fully deductible against any income, no $3K cap (with a five-year lookback recapture rule when later 1231 gains arrive). A genuine loss on a rental building deducts like a business expense, not a stock loss. Passive-loss release: suspended passive losses from a rental unlock fully in the year you dispose of the activity — a taxable sale can detonate years of banked deductions at once. Both exceptions reward CPA sequencing.

Where this meets exchange planning

Sellers holding large loss carryforwards sometimes shouldn’t exchange: recognizing gain into a waiting pile of losses is a free step-up in basis — the rare year when the taxable sale wins the math. The reverse also holds: burning carryforwards on a gain you could have deferred, in a year you didn’t need to sell, wastes the vouchers. The decision is arithmetic, not doctrine; run it both ways before listing anything with meaningful gain.