An unrealized loss tax deduction generally isn’t available: federal law requires you to actually sell or otherwise dispose of an investment before the loss counts. A drop in your portfolio’s value is just a number on a statement until a taxable event turns it into a realized loss. A few narrow rules break this pattern, and there are ways to convert paper losses into deductions on purpose, but the default answer to “can I deduct this?” is no while you still own the asset.
Why a Paper Loss Isn’t Deductible
Federal tax law follows the realization principle. No gain or loss exists for tax purposes until a sale, exchange, or other disposition happens. Buy a stock at $50, watch it fall to $30, and you have a $20-per-share paper loss that the IRS does not recognize because you still own the shares. The price could recover next week or keep falling. The system doesn’t try to track those swings.
There’s a practical reason for the rule. If unrealized losses were deductible, taxpayers could claim deductions on positions they never intended to sell, then enjoy the recovery without reporting the corresponding gain. A sale creates a clean event with a date, a price, and a brokerage record the IRS can verify.
Turning a Paper Loss Into a Deductible One
For most investments, the only way to deduct a loss is to sell. Once you close the position below your cost basis, the loss is realized and enters the tax system. Investors often do this deliberately near year-end through tax-loss harvesting: selling losing positions to offset gains realized earlier in the year.
The math is simple. If you realized $10,000 in capital gains from one investment and $7,000 in capital losses from another, your net taxable gain is $3,000. You report the transactions on Form 8949, and the totals flow to Schedule D of Form 1040.1Internal Revenue Service. Instructions for Form 8949
The Wash Sale Rule Can Void the Deduction
Harvesting has an important constraint. If you sell a security at a loss and buy the same or a “substantially identical” security within 30 days before or after the sale, the IRS disallows the loss. The wash sale rule covers a 61-day window around the sale date.2Office of the Law Revision Counsel. 26 US Code 1091 – Loss From Wash Sales of Stock or Securities
The disallowed loss isn’t gone forever. It gets added to the cost basis of the replacement security, so the deduction is postponed until you sell that replacement, not eliminated.3eCFR. 26 CFR 1.1091-1 – Losses From Wash Sales of Stock or Securities
What counts as “substantially identical” isn’t spelled out by statute. Selling one S&P 500 index fund and buying another provider’s S&P 500 fund would likely trigger the rule. Selling an S&P 500 fund and buying a total-market fund is generally treated as different enough, but this is a gray area.
One boundary worth knowing: the wash sale rule applies to “stock or securities,” and as of 2026 the IRS classifies cryptocurrency as property. No finalized federal law extends wash sale treatment to digital assets, though the White House has recommended Congress do so. Crypto investors can currently sell a coin at a loss and repurchase it immediately without triggering a wash sale disallowance.
How Much of a Net Loss You Can Actually Deduct
After netting your realized gains and losses for the year, any remaining net capital loss is deductible against ordinary income like wages or interest, but only up to $3,000 per year. Married filing separately drops the cap to $1,500.4Office of the Law Revision Counsel. 26 USC 1211 – Limitation on Capital Losses
A large realized loss in one year does not produce a large deduction that year. If you have $25,000 in net capital losses, you deduct $3,000 now and carry $22,000 forward. The carryover keeps its short-term or long-term character and can be used against future capital gains or ordinary income in later years, with no expiration.5Office of the Law Revision Counsel. 26 USC 1212 – Capital Loss Carrybacks and Carryovers
The netting itself happens by category. Short-term losses net against short-term gains first, and long-term losses net against long-term gains. If one category is net positive and the other is net negative, the two offset. Only the final combined figure hits the $3,000 cap.6Internal Revenue Service. Topic No. 409, Capital Gains and Losses Because short-term gains are taxed at ordinary rates, harvesting short-term losses first is often more valuable when you have a choice.
Losses the Sale Trick Won’t Save
Selling doesn’t make every loss deductible. If you sell your home, car, furniture, or other personal-use property below what you paid, the loss is not deductible at all. The tax code allows loss deductions only on property used in a trade or business or held as an investment.7Internal Revenue Service. Capital Gains, Losses, and Sale of Home
The asymmetry catches homeowners off guard. Sell a $400,000 house for $350,000 and the $50,000 loss appears nowhere on your return, even though a gain above the exclusion would have been taxable.
Situations Where No Sale Is Required
Worthless Securities
If a stock or bond becomes completely worthless, you don’t need to find a buyer. The tax code treats a worthless security as sold for zero on the last day of the tax year in which it became worthless.8GovInfo. 26 USC 165 – Losses
Proving worthlessness is the hard part. You need to show the company has no assets, no operations, and no reasonable prospect of future value. A stock trading at a penny is not worthless; it has a price. A company that filed for Chapter 7, distributed remaining assets, and dissolved is. The resulting loss is a capital loss subject to the same $3,000 annual limit.9Internal Revenue Service. Losses (Homes, Stocks, Other Property)
Section 1256 Contracts
Certain instruments bypass the realization principle entirely. Regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, and dealer securities futures contracts fall under Section 1256. Any of these still open at year-end are treated as sold at fair market value on the last business day of the year, whether you sold or not.10Office of the Law Revision Counsel. 26 USC 1256 – Section 1256 Contracts Marked to Market
This mandatory mark-to-market treatment makes unrealized losses on these contracts deductible in the year they occur. Gains and losses get a 60/40 split: 60% long-term and 40% short-term, regardless of holding period. Regular stock options, interest rate swaps, credit default swaps, and equity swaps are excluded. Section 1256 activity is reported on Form 6781.
The Mark-to-Market Election for Traders
Ordinary investors cannot deduct unrealized stock losses. Someone who qualifies as a trader in securities, meaning trading is a genuine business rather than a side activity, can elect mark-to-market accounting under Section 475(f). The election treats every position as sold at fair market value on the last day of the year, and all gains and losses become ordinary rather than capital.11Internal Revenue Service. Topic No. 429, Traders in Securities
Ordinary losses aren’t subject to the $3,000 capital loss cap, and the wash sale rule doesn’t apply. A bad year with $50,000 in losses produces a $50,000 deduction against other income. The trade-off is that gains are also ordinary income at your full rate, so you give up the lower long-term capital gains rates.
The election has a strict deadline. You file a statement with your tax return for the year before the election takes effect, by that return’s original due date without extensions. To use mark-to-market for 2026, the statement had to be filed with the 2025 return by April 15, 2026. New taxpayers who didn’t file a prior-year return have two months and 15 days after the start of the election year.11Internal Revenue Service. Topic No. 429, Traders in Securities
The IRS doesn’t define “trader” with a bright-line test. Courts look at whether you trade frequently, substantially, and continuously to profit from short-term price swings. Buy-and-hold investors and occasional traders don’t qualify, and claiming the status without meeting it invites an audit that reclassifies losses as capital.
What Happens If You Hold the Loss Until Death
Unrealized losses disappear at death. When someone inherits an investment, the cost basis resets to the fair market value on the date the original owner died, not what the owner originally paid.12Office of the Law Revision Counsel. 26 US Code 1014 – Basis of Property Acquired From a Decedent
If a parent bought stock at $100 per share and it was worth $40 when they died, the heir’s basis is $40. The $60 paper loss vanishes. Sell the inherited stock later at $35, and the loss is $5, not $65.
For anyone holding significant paper losses in a taxable account, this is worth thinking through. Selling before death locks in a deductible loss, even if only $3,000 flows through each year. Holding the position until death means the tax benefit of the decline is lost to everyone.