My portfolio dropped quite a bit in 2022. Can you write a column about capital losses?

— L.O.P., e-mail

Our initial response to your question deals with what are termed rhetoric losses versus real losses. Rhetoric losses are paper losses (i.e., total capital asset holdings drop in value). Real losses represent capital losses that actually occurred as the result of a sale, trade or exchange. Rhetoric losses are painful but cannot be recognized on your income tax return.

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Real losses are allowed on an income tax return. First classify the losses as short-term or long-term capital losses. Note: Capital assets held for a year or less are short-term, while a holding period of more than one year has a long-term label.

Capital losses are fully deductible against capital gains on Schedule D. If capital losses exceed capital gains, up to $3,000 of ordinary income can be offset with the rule being short-term losses are used first. Capital losses over $3,000 can be carried over. Note: In a married filing separately situation, the loss offset is reduced to $1,500.

When carrying the capital losses forward, the short-term and long-term carryover figures retain their classification. Put differently, the short-term and long-term losses cannot be combined when moving into the future.

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Here's an example to illustrate the above. A taxpayer's 2022 capital activity includes a short-term capital gain of $6,800 and a short-term capital loss of $8,000. The result is a net short term capital loss equal to $1,200. The same taxpayer's long-term activity shows a $4,200 capital loss. Combined the overall capital loss is $5,400. When $3,000 is used to offset 2022 ordinary income, the $1,200 from the short-term category is used up first while the remaining $1,800 comes from the long-term classification. Thus, the $2,400 (i.e., $5,400 - $3,000) carryover is all long-term when reported on the taxpayer's 2023 income tax return. FYI, if a capital loss carryover exceeds future capital gains and/or the $3,000 per year horizon, it can be carried over indefinitely.

Ken & Klee's Tax Notebook — Last week the IRS rolled out its annual "Dirty Dozen," which includes the worst of the tax scams they've encountered this year. Near the top of the list are e-mail and text frauds. Scammers tend to use the tax season relentlessly as a way of tricking people. Folks are anxious to receive the latest information about a refund or other income tax issue. Scammers posing as the IRS, a state tax agency or others in the tax industry are aware of this and prey on people. Please be incredibly wary about unexpected messages since more often than not they can be a trap.

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USA Facts recently reported on a Census Bureau study comparing each state's income tax revenue as a percent of personal income for that state. While nine states (i.e., Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington & Wyoming) have a limited or no income tax, states like New York (4.7%) and Maryland (4.2%) are the most expensive from a state income tax standpoint. Michigan's 1.8% was the 16th lowest and Indiana's 2.7% tally put the Hoosier state at 39 according to the report.

If you are self-employed and/or deduct business mileage, the increase in fuel costs led to a mileage rate change as of July 1, 2022, of four cents (i.e., from 58.5 cents to 62.5 cents/mile). The medical and moving expense mileage rate also got a four cent/mile hike moving from 18 to 22 cents. Charitable mileage continues to be (for the 24th straight year) 14 cents/mile.

Rick Klee served as the tax director at the University of Notre Dame from 1998 through August 2019. A retired CPA, Klee is a graduate of Notre Dame. You can contact him at rklee@nd.edu.

Ken Milani is a professor of accountancy at Notre Dame where he served as the faculty coordinator of the Notre Dame Tax Assistance Program. Contact him at milani.1@nd.edu.

E-mail questions to either.

This article originally appeared on South Bend Tribune: Tax Talk: Portfolio losses do not equate to a capital loss