If You Lose Money in the Stock Market, Will It Lower Your Taxes at the End of the Year?

Whether you're an investing professional or a total market novice, the idea of losing money probably makes you uncomfortable. There's no shame in this fact. Folks who can stomach the idea of losing significant amounts of cash probably shouldn't be managing their own investments. It takes diligence, ambition and a competitive spirit to be successful in the market. Some people simply don't possess the drive necessary to make a killing in the stock or bond markets. Others are bored by the reams of data that successful investors must review on a regular basis. If you're one of these people, you shouldn't feel bad about it.

You also shouldn't feel bad about letting someone else manage your investments. After all, plenty of financial professionals make a living by beating the returns that the broader market offers. If you can afford to pay one of these folks to boost your portfolio's performance, it's perfectly acceptable for you to do so.

Whether you're managing your own investments or outsourcing the job to a professional, you'll need to know how to manage your tax situation. Even small-time investors tend to have complicated tax situations that can quickly overwhelm the free-filing software that many tax-preparation services use. Before you attempt to file taxes on your own, you may wish to retain a qualified tax professional. Depending upon your investment manager's specific qualifications, he or she may be able to fill this role as well.

In either case, you'll need to account for your total investment-related gain or loss. Since this requires you to calculate the "cost basis" for each equity that you purchased over the course of the year, it can be a painstaking and error-prone process. After you've found each individual equity's cost basis, you'll need to determine its selling price. For the purposes of this calculation, you can ignore any equities that you held throughout the entire year.

If you lost money on the sale of an equity, you can reduce your taxable income by the amount of the loss. Although you can't reduce your taxable income by more than $3,000 in the aggregate, you can claim larger losses on future tax returns. On the other hand, you must add any equity-related earnings to your taxable income. These are taxed at the applicable capital gains rates. Separately, you'll need to account for all of the dividends that you earned over the course of the year as well. For tax purposes, these are categorized as regular income.

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