Tax Loss Carryforward

What it is

A tax loss carryforward (or carryover) lets individuals or businesses apply a tax loss from one year to reduce taxable income in future years. It helps smooth tax obligations across profitable and unprofitable periods.

Key takeaways

• Two main types: net operating loss (NOL) carryforwards and capital loss carryforwards.
• NOL carryforwards chiefly apply to businesses; capital loss rules differ for individuals and corporations.
• Federal rules limit NOL use to 80% of taxable income for applicable years; state rules may vary.
• Individuals may deduct up to $3,000 of net capital losses against ordinary income per year ($1,500 if married filing separately); excess can be carried forward.

Net Operating Loss (NOL) Carryforwards

An NOL occurs when a taxpayer’s allowable deductions exceed taxable income. Under current federal rules:

• NOLs generally can be carried forward indefinitely to offset future taxable income, but the amount used in any year is limited to 80% of that year’s taxable income (for NOLs arising under the applicable post-2017 rules).
• The prior rule allowing a two-year carryback was largely removed (with some exceptions, such as certain farming losses).

Example
* A company loses $5 million in 2023 and earns $6 million in 2024. It can apply up to 80% of 2024’s taxable income — $4.8 million — against the NOL. Taxable income for 2024 becomes $1.2 million, and $200,000 of the original NOL remains available to carry forward to later years.

Capital Loss Carryforwards

Capital losses arise when the sale price of a capital asset (stocks, bonds, real estate, equipment) is less than its tax basis. How losses are used depends on the taxpayer type.

Individuals
* Net capital losses can offset capital gains in the same year.
If net capital losses exceed gains, individuals may deduct up to $3,000 of the excess against ordinary income each tax year ($1,500 if married filing separately).
Any unused loss beyond that annual limit can be carried forward indefinitely until used.

Corporations
* Corporations can use capital losses to offset capital gains. Specific carryback and carryforward sequences may apply (for example: carryback starting three years prior, then two years prior, then one year prior; remaining loss carried forward for several years), depending on tax rules in effect. (Corporate rules can differ from individual rules and from state rules.)

Example
* An investor has $10,000 in capital losses and $2,000 in capital gains in the same year, for a net $8,000 loss. They can deduct $3,000 against ordinary income this year and carry forward $5,000 to future years.

Cost Basis of Stock

The cost basis is generally the purchase price plus fees and any reinvested dividends, adjusted for improvements or depreciation where relevant. For inherited assets, basis is typically the asset’s fair market value at the decedent’s date of death.

Tax Loss Harvesting and Wash Sales

Tax loss harvesting is selling securities at a loss to realize the loss for tax purposes and then replacing them with similar investments. It’s a legal strategy but must avoid the wash sale rule: you cannot buy a “substantially similar” security within 30 days before or after the sale if you intend to claim the loss.

State Tax Considerations

State rules for NOL and capital loss carryforwards vary. Some states adopt federal treatment, while others impose different limits or time frames. Check state tax law or consult a tax professional for state-specific rules.

Bottom line

Carryforwards turn losses into future tax relief, reducing taxable income in profitable years. NOL and capital loss rules differ for individuals and corporations and are subject to federal limitations and varying state treatments. For complex situations, especially for businesses, consult a tax advisor to optimize carryforward use and ensure compliance.