Gambling losses are indeed tax deductible, but only to the extent of your winnings. The IRS requires you to report all the money you win as taxable income on your return. The deduction for losses is only available if you itemize your deductions. If you claim the standard deduction, then you can't reduce your tax by your gambling losses.
Although you cannot report a gambling loss, the IRS and Tax Court agree that you can reduce gross winnings by your original wager plus any unrealized losses. “Fluctuating wins and losses left in play
are not accessions to wealth until the taxpayer redeems her tokens and can definitively calculate the amount above or below basis (the wager) realized,” the IRS said in a Chief Counsel Advise Memorandum.
For example, suppose you visit a casino on Monday and put $500 on your casino card. You quickly win $2,000, but keep gambling until your balance drops to $1,500. The next day (Tuesday) you lose your remaining $1,500.
How is this reported?
Your net gambling win is $1,000 and is reported on Form 1040 ($1,500 cash out - $500 original wager). Your gambling loss is $1,000 and is reported Schedule A. Even though you actually lost $2,500 (your original $500 + the $2,000 jackpot), your gambling deduction is limited to the extent of winnings.
You cannot net Monday’s gambling winnings against Tuesday’s gambling loss to report $0 of gambling income because the win and loss occurred in different “sessions” (days). However, your net gambling win includes the difference between the $2,000 jackpot and the $1,500 you walked out the door with. You only pay tax on the end of session gain ($1,500 - $500 original wager).
Bear in mind the IRS may come calling if you report $1,000 of gambling income and the casino reports a $2,000 jackpot on Form W-2G. The IRS may ask for detailed, contemporaneous records proving your income. Taxpayers have lost court cases over poor or inadequate recordkeeping.
The bottom line is that losing money at a casino or the race track does not by itself reduce your tax bill. You owe tax on winnings before a loss deduction is available. Therefore, at best, deducting your losses allows you to avoid paying tax on your winnings, but nothing more.
