What is a 'Tax Loss Carryforward'

A tax loss carryforward is a tax policy that allows an investor to use realized capital losses to offset the taxation of capital gains in future years. When an asset is sold for a gain, the tax code refers to the transaction as a capital gain. The assessed value of an asset is the sale price received by the seller. The difference between the sale price and the asset's cost is subject to taxation

BREAKING DOWN 'Tax Loss Carryforward'

In addition to selling investments, the sale of a home results in a capital gain, and the property tax base of a house is its assessed value, which may or may not be the sale price recognized. The property tax base of a city is the collective value of all taxable real estate in the city.

Factoring in Capital Gains and Losses

A capital gain or loss is unrealized if you own an asset and have not sold it, while a realized capital gain or loss requires a buy and a sell transaction. A realized capital gain generates a tax liability, and a capital loss can be used to offset your tax liability for gains. When you sell a stock at a loss, for example, the tax code provides a tax loss carryforward process to offset other capital gains and reduce your tax liability, including capital gains realized in the future years.

A tax loss carryforward is different from a loss carryforward. Loss carryforward applies to companies that make net operating loss on income, not on capital losses. 

Assume, for example, that you sell 1,000 shares of XYZ stock for a capital loss totaling $10,000 and that you owned the stock for three years. Capital gains and losses are reported on schedule D of the IRS Form 1040 tax return. If a stock is held more than a year, the holding period is long-term, and the taxpayer offsets long-term gains with long-term losses. Assume that the taxpayer has $3,000 in long-term gains, which reduces the long-term capital loss to $7,000. For this example, assume that the loss is then reduced by $2,000 in short-term capital gains and that $1,000 of the loss is used to reduce other income on the return. The remaining capital loss is $4,000.

How Losses Are Carried Forward

The tax loss carryforward rules allow the taxpayer to offset the $4,000 loss with future capital gains until the entire remaining loss is used for tax purposes. If the taxpayer has $2,000 in capital gains next year, those gains can be offset by $2,000 of the losses that are carried forward. This tax policy allows investors who realize large losses during market downturns to reduce gains recognized over many future years.

Famous Example

In 2016, leading into the presidential vote the New York Times released Donald Trump's 1995 tax return. Trump, who had stubbornly refused to release his tax records during the race reported a loss of $916 million in 1995, which he was able to carryforward. The losses were on realized capital losses from investments in casino's, airline business ventures and Manhattan property. The Times reported that this loss would allow him to avoid federal tax of $50 million for up to 18 years. 

RELATED TERMS
  1. Loss Carryforward

    An accounting technique that applies the current year's net operating ...
  2. Capital Loss

    The loss incurred when a capital asset (investment or real estate) ...
  3. Capital Loss Carryover

    The net amount of capital losses that aren't deductible for the ...
  4. Long-Term Capital Gain or Loss

    A gain or loss from a qualifying investment owned for longer ...
  5. Short-Term Loss

    A capital loss realized on the sale or exchange of a capital ...
  6. Capital Gain

    1. An increase in the value of a capital asset (investment or ...
Related Articles
  1. Investing

    What's a Loss Carryforward?

    Loss carryforward is an accounting technique that applies a business’ net operating losses in one year to a future year’s profits.
  2. Taxes

    Capital Losses and Tax

    Capital losses are never fun to incur, but they can reduce your taxable income. Knowing the rules for capital losses can help you maximize your deductions and make better choices about when to ...
  3. Managing Wealth

    Capital Losses and Tax

    When an investment sells for less than its purchase price, the difference is a capital loss.
  4. Investing

    7 Year-End Tax Planning Strategies

    Do you have a capital loss that could be booked and used to offset future tax liabilities? If so, it may be time to sell.
  5. Financial Advisor

    Top Tips for Deducting Stock Losses

    Investors who know the rules can turn their losing picks into tax savings. Here's how to deduct your stock losses.
  6. Investing

    Seek Out Past Losses To Uncover Future Gains

    Tax loss carry-forwards can help reduce the tax burden of owning a profitable fund.
  7. Financial Advisor

    Here's the Best Way to Skirt Capital Gains Taxes

    Taxpayers who know the rules for netting gains/losses can generate additional losses to net against the taxable gains in their portfolios. Here's how.
  8. Financial Advisor

    How to Help Clients Harvest Tax Losses by Year End

    Here's how to help clients employ tax-loss harvesting to reduce their taxes before year end.
  9. Taxes

    Capital Gains Tax 101

    Find out how taxes are applied to your investment returns and how you can reduce your tax burden.
  10. Managing Wealth

    Understanding the Capital Gains Tax

    A capital gains tax is imposed on the profits realized when an investor or corporation sells an asset for a higher price than its purchase price.
Hot Definitions
  1. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  2. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  3. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  4. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
  5. Mezzanine Financing

    A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. Mezzanine financing ...
  6. Long Run

    A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all ...
Trading Center