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

How are capital losses applied against ordinary income if they exceed allowable limits?

1. They are deducted from future capital gains

2. They are subject to a different tax rate

3. They are rolled over to subsequent tax years

4. They can be used to offset business income

The correct answer is: They are rolled over to subsequent tax years

When capital losses exceed the allowable limits for offsetting capital gains, the excess losses can be rolled over to subsequent tax years. The Internal Revenue Service (IRS) allows taxpayers to carry forward unused capital losses to future tax years, where they can be used to offset future capital gains as well as up to $3,000 of ordinary income each year ($1,500 if married filing separately). This provision helps taxpayers utilize their losses over time, providing a potential tax relief in future years. Other options, while they touch on tax treatments, do not accurately represent how excess capital losses are managed. For instance, while capital losses can indeed reduce future capital gains, they are not specifically "deducted from future capital gains” until those gains are realized, making the first choice misleading. The idea that capital losses are subject to a different tax rate is not correct; losses themselves do not incur a tax rate but rather are leveraged to minimize taxes owed on cash flows. Lastly, capital losses cannot be used to offset business income, as they are generally restricted to offsetting capital gains and ordinary income within the limits set by tax law. Thus, rolling over to subsequent years is the most accurate and relevant handling of excess capital losses.