What Is Tax Loss Carryforward?
A tax loss carryforward (or carryover) is a provision that allows a taxpayer to carry over a tax loss to future years to offset a profit. The tax loss carryforward can be claimed by an individual or a business in order to reduce any future tax payments.
- A tax loss carryforward allows taxpayers to utilize a taxable loss in the current period and instead apply it to a future tax period.
- Capital losses that exceed capital gains in a year may be used to offset ordinary taxable income up to $3,000 in any one tax year.
- Tax losses can also be carried forward from losses incurred in business pursuits, but those are labeled simply loss carryover.
How Tax Loss Carryforward Works
Consider a tax loss carryforward to be the opposite of profit, or a negative profit, for tax purposes. It happens when expenses are greater than revenue or capital losses are greater than capital gains. This provision is a great tool for creating future tax relief. In most cases, the carryforward can be valid for up to seven years, although most states do have their own rules.
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. Tax loss carryforwards may also accrue to individuals tax returns that report business losses, losses on rental properties, and gambling losses (in some cases). Note that a tax loss carryforward is different from a loss carryforward. Loss carryforward applies to incorporated companies that make a net operating loss on income, not on capital losses.
Factoring in Capital Gains/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 sale 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.
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 for 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. 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.
In 2016, leading into the presidential vote, The New York Times released Donald Trump's 1995 tax return. Trump, who had refused to release his tax records during the race, reported a loss of $916 million in 1995, which he was able to carry forward. The losses were on realized capital losses from investments in casinos, airline business ventures, and Manhattan property. The Times reported that this loss would allow him to avoid a federal tax of $50 million for up to 18 years.