Intuit Academy Tax Practice Exam

For tax purposes, which of the following statements regarding capital losses is true?

1. They can only offset capital gains

2. They can reduce ordinary income up to $3,000

3. They are not deductible at all

4. They can be rolled over indefinitely

The correct answer is: They can reduce ordinary income up to $3,000

The correct statement regarding capital losses is that they can reduce ordinary income up to $3,000. For tax purposes, individuals can use capital losses to offset capital gains first. If the total capital losses exceed capital gains, individuals can then apply up to $3,000 of the remaining losses against ordinary income for the tax year. This provision is particularly beneficial as it allows taxpayers to reduce their overall taxable income, thus potentially lowering their tax liability. If a taxpayer's capital losses exceed the $3,000 limit, the remaining losses can be carried forward to future tax years to offset future capital gains or ordinary income, but this is not unlimited and must comply with IRS guidelines on net operating losses and capital loss limitations. Therefore, this strategy allows for more flexible tax planning for individuals with investments that are not performing well. The other options presented do not accurately reflect the tax treatment of capital losses. They cannot only offset capital gains, as they can also reduce ordinary income within the allowed limits. They are deductible, albeit with constraints, and rolling over indefinitely is not entirely accurate as there are specific parameters for carrying forward losses.