Understanding Tax Loss Carryforwards

It’s not unlikely to experience losses while owning a business or investing. This is when your returns from selling assets or operating a business are fewer than your expenses. Normally, this would lead to a larger tax liability in the year you incurred a loss. However, a strategy to reduce this burden is tax loss carryforward.

In this article, we’ll break down how carrying forward your tax losses into future years works. We’ll also explain the two varying types of eligible losses you can carry over and how a financial advisor can help ensure you’re on the right track and avoid issues.

What Are Tax Loss Carryforwards?

Tax loss carryforward is an Internal Revenue Code (IRC) provision that lets both individuals and businesses use a loss in a certain year to reduce tax liability in a future one. More specifically, you lower the amount of income you claim in another year with the losses you’ve incurred in a previous one, allowing you to have a smaller taxable income.

According to R.J. Weiss, a certified financial planner (CFP) and CEO of the personal finance site, The Ways to Wealth, “The idea is for investors who have losses in one year to get some relief from their tax bill due to those losses in future years.”

It’s important to note, however, that the rules for carrying over tax losses vary based on whether you’re a business or an individual. Businesses can do so if they experience a net operating loss (NOL). On the other hand, individuals can carry forward and deduct the lower of $3,000 ($1,500 for married couples filing separately) or the total realized loss they’ve experienced from selling capital assets, such as real estate, equities, or fixed-income securities.

Two Types of Eligible Losses

There are two types of eligible losses you can carry over, each depending on which type of taxpayer you are — a business or individual. “You can carry forward capital losses from investments and business operating losses,” explains Weiss.

Below is a closer explanation of the two eligible types of losses for carryforwards:

Capital Loss Carryover

One of the losses you’re able to carry forward to reduce your tax liability is realized capital losses from selling assets or investments you own. This is most common if you’re an individual retail investor, and have taken losses from selling securities such as:

• Your home or land
• Stocks
• Shares in a mutual or index fund
• Bonds
• Alternative assets, such as collectibles or cryptocurrency
• Commodities
• Your business

It’s important to note that eligible capital losses for carryforwards must be realized losses, as per the IRC. That is, you must have sold an asset and taken a loss due to its lowered value. “For example, if you sell a [publicly] traded stock at a loss, that loss can be carried forward to offset gains in future years,” Weiss says.

Net Operating Income Loss

The second eligible loss for carrying over is business net operating losses (NOLs). A company experiences an NOL when it has more deductions than income in one year. When this occurs, a business or its owner can claim the NOL on their taxes in future years to reduce their taxable income.

Weiss says that unlike with capital losses, “You don’t need to sell the business to have a loss. Instead, it’s based on the company’s operating income that year. If the business has an operating loss, that loss can be carried forward to offset future income.”

As noted, NOL carryforwards come with different regulations than their capital loss counterparts. Because of the Tax Cuts and Jobs Act (TCJA), which has been in effect since 2018, businesses may carry their NOLs forward indefinitely; however, they are only able to deduct 80% of their taxable income. State laws may also vary, though, affecting how much or how far a business could carry losses into future years.

“Business losses have different rules and limitations based on your business structure,” Weiss says. “If there are substantial losses, it can get complex, so it’s helpful to get a good CPA involved to ensure everything is handled correctly and to maximize your potential benefits,” he continues.

How a Financial Advisor Can Help

It’s no secret that taxes, while an important part of everyone’s lives, can be a difficult subject to wrap your head around. And if you believe you’re eligible to carry losses forward into future years, it can be even more nuanced to ensure you follow regulations and document your deductions carefully. For this reason, employing the services of a financial advisor or tax professional can be invaluable.

In the specific case of carryforwards, when you work with an expert, you’ll have peace of mind knowing that you’re in a positive situation to carry over losses and get the correct deductions. Moreover, they can help you better understand regulations and let you know about rules you may not have known you needed to follow.

For instance, Weiss, a financial professional, underscores that a key adjacent regulation surrounding optimizing tax losses is the wash-sale rule. According to him, “Understanding [this] is important, as it allows you to claim a loss for tax purposes while maintaining an investment position.” He continues, “This rule states that you can’t repurchase the same or substantially identical security within 30 days before or after the sale to claim the loss.”

Ultimately, working closely with an advisor can ensure that you adhere to rules, while also collecting the benefits of realizing losses. They’ll also be able to help you feel more comfortable dealing with complex tax deductions and forms, taking some of the pressure off your shoulders. If you’re unsure of how to find a financial advisor, we recommend using a free matching tool, such as this one. After answering a few questions about your goals and circumstances, it’ll present you with up to three reputable experts.

Frequently Asked Questions

How many years can you carry forward a tax loss?

How many years into the future you can carry forward a tax loss depends on factors such as the type of loss you would like to claim and your state’s laws. For instance, if you’re carrying capital losses over, you can do so indefinitely into each consecutive year. The same is true for net operating income losses; however, state laws may dictate how far you can carry losses.

What is an example of a capital loss carryover?

A capital loss carryover is when you use a realized loss from selling a capital asset, such as stocks or bonds, to reduce your income in a future year. According to Weiss, “Capital losses can only offset up to $3,000 of ordinary income per year, but the remaining loss can carry forward indefinitely. So, a $30,000 capital loss would allow you to offset $3,000 of ordinary income each year. Or, if you have a $10,000 gain the following year, you can offset that entire gain with your remaining loss.”

What is the biggest benefit of carrying forward losses?

The most helpful benefit of tax loss carryforwards is reducing the amount of money you owe on taxes in future years. That is, even if you experience a loss, you can use it to your advantage and leverage it to, in some cases, drastically lower your taxable income in other years.

How does the wash-sale rule specifically impact carryforwards?

The wash-sale rule prevents you from claiming a loss if you purchase an identical (or substantially identical) asset either 30 days before or after a sale. Therefore, if you sell an asset in which you realize a loss (i.e., selling it for less than you purchased it for), buying something too similar in these 61 days would disallow you from claiming the loss on your taxes and potentially carrying it forward to future years.

Weiss offers the scenario that “selling an S&P 500 index ETF at a loss on December 31st and purchasing it again on January 1st doesn’t count as a loss,” but says that it’s possible to “get creative,” adding that, “[f]or example, if you have an index fund of the S&P 500, you can replace it with a total stock market fund to stay in the market while still realizing the loss.”