Investment Company and Variable Contracts Products Representative (Series 6)Practice Exam

What is the first use of capital losses?

1. Deductions against capital gains

2. Offsets against ordinary income

3. Carried forward to subsequent years

4. Converted into tax credits

The correct answer is: Deductions against capital gains

The first use of capital losses is to offset capital gains. This means that if an individual has realized gains from selling assets, they can deduct any realized capital losses from those gains, thus reducing their overall taxable income. This deduction helps to minimize the amount of capital gains tax that an individual might owe. It's important to recognize that capital losses specifically serve to counterbalance capital gains before any consideration is given to other tax benefits associated with those losses. For instance, if an investor sells a stock for a profit (a capital gain) and also sells another stock at a loss (a capital loss), the loss can be directly applied to reduce the gain, thereby decreasing the taxable income which results from the profitable sale. While there are additional provisions for capital losses, such as using them to offset ordinary income or carrying them forward to future tax years, the primary function and first application remain the deduction against capital gains. This is integral to tax planning for investors and provides a direct benefit in managing investment returns and tax liabilities.