Tax Loss Carryforwards: How They Work, Types, and Examples (2024)

What Is a Tax Loss Carryforward?

A tax loss carryforward (or carryover) is an Internal Revenue Service (IRS) provision that allows businesses or individuals to carry a tax loss from one year into future years to offset a portion of their taxable income.

Key Takeaways:

  • A tax loss carryforward allows taxpayers to use a loss from one year to offset income in future years.
  • There are two types of tax loss carryforwards: net operating loss (NOL) carryforwards and capital loss carryforwards.
  • Net operating loss carryforwards apply to businesses.
  • Capital loss carryforwards can apply to either businesses or individuals, although the rules work differently.

How Tax Loss Carryforwards Work

There are two main types of tax loss carryforwards: net operating loss (NOL) carryforwards and capital loss carryforwards or carryovers.

Net Operating Loss (NOL) Carryforwards

A net operating loss or NOL occurs when a company's allowable deductions exceed its taxable income for a particular tax year. The amount of the NOL can be used to offset a portion of the company's taxable income in future tax years through anIRS provision called a carryforward. For example, if a company experiences negativenet operating income (NOI) in year one, but positive NOI in the two subsequent years, it can use its NOL carryforward to reduce its taxable income in the latter years.

The purpose behind this tax provision is to allow some form oftax reliefwhen a company loses money in a particular tax period. Because the company pays taxes only in years of positive NOI, the only way to minimize the tax impact of the loss is to offset income in positive NOI years.

The tax laws recognize that some businesses are cyclical in nature. For example, a tourism business is subject to weather conditions and may have significant profitsand a large tax obligation in one year, incur an NOL in the next, and then follow that with another profitable year. To smooth the tax burden, the loss carryforward provision allows for the NOL in the second year to offset taxes due in the third year.

Limitations on Net Operating Loss Carryforwards

Prior to the implementation of theTax Cuts and Jobs Act (TCJA) in 2018, the IRS allowed businesses to carry NOLs forward 20 years to net against future profits or backward two years for an immediate refund of previous taxes paid. After 20 years, any remaining losses expired and could no longer be used to reduce taxable income.

For tax years beginning Jan. 1, 2018, or later, the law removed the two-year carryback provision, except for certain farming losses, and instituted an indefinite carryforward period. However, carryforwards are now limited to 80% of each subsequent year's net income.

Example of a Net Operating Loss Carryforward

For a simple example of the NOL carryforward rules post-TCJA, suppose a company lost $5 million in 2022 and earned $6 million in 2023. Its carryforward limit for 2023 would be 80% of $6 million, or $4.8 million. That $4.8 million carryforward would lower the company's taxable income for 2023 to $1.2 million ($6 million minus $4.8 million).

That would still leave a $200,000 NOL carryforward(the company's $5 million 2022 NOL minus the $4.8 million NOL carryforward it used in 2023). The company could use the $200,000 carryforward in 2024 or later, depending on when it next turns a profit.

Capital Loss Carryforwards

Capital gains and losses result from the sale of capital assets, such as stocks, bonds, industrial equipment, and real estate. When capital assets are sold, the gain (or loss) on the sale is the difference between its selling price and its tax or cost basis (generally, the purchase price of the asset plus the cost of any improvements and minus any depreciation deductions taken in prior years). If the selling price is greater than the basis, the result is a capital gain. If the selling price is less than the basis, the result is a capital loss.

Both companies and individuals can have capital loss carryforwards, although the rules are different. In the case of a corporation, capital losses can be used only to offset capital gains. The company can carry its capital losses both forward and backward and must do so in this order: starting with the year three years prior, followed by two years prior, and then one year prior. If any loss remains after that, the company can carry it forward for the next five years.

For individuals, net capital losses (the amount by which total capital losses exceed total capital gains in a given year) can be used to offset ordinary income, but only up to a maximum of $3,000 in a tax year ($1,500 for married individuals filing separately). Losses exceeding the $3,000 threshold may be carried over to future tax years until they've been exhausted. There is no limit on the number of years that a taxpayer can carry a capital loss forward.

Example of a Capital Loss Carryforward

Here is a simplified example of how an individual taxpayer might use a capital loss carryforward. Assume the taxpayer sold 1,000 shares of XYZ stock for $10,000 less than their cost basis in the stock. They now have a $10,000 capital loss. If they also had a $2,000 capital gain from selling some other stock, their net capital loss for the year is $8,000.

They can take $3,000 of that loss as a deduction on their current year tax return. The remaining loss of $5,000 can be carried forward to the next tax year to offset another $3,000 in income. That leaves them $2,000 for the year after that.

How Is the Cost Basis of a Stock Determined?

The cost basis of a stock is generally the amount you paid for your shares plus any dividends that you reinvested. In addition, you can add in any commissions or fees you paid as a part of those transactions. If you inherited the stock, its basis is whatever it was worth when the person who left it to you died.

What Is Tax Loss Harvesting?

Tax loss harvesting is a strategy in which an investor sells an investment at a loss, replaces it in their portfolio with a similar investment, and uses the capital loss to offset their gains or other income. Tax loss harvesting is legal, but investors have to be careful not to run afoul of wash sale rules, which prohibit buying a "substantially similar" security within 30 days of selling.

Can a Business Claim an NOL Carryforward on Its State Taxes?

State laws on NOL carryforwards can vary. Some follow the federal rules, while others set different dollar caps or time limits for carryforwards. Similarly, state laws on capital loss carryforwards can differ from the federal ones.

The Bottom Line

Businesses and individuals typically prefer profits to losses. However, losses have one upside: the ability to use them to offset gains, sometimes years into the future, through a carryforward.

Tax Loss Carryforwards: How They Work, Types, and Examples (2024)


What is an example of a tax loss carryforward? ›

For a simple example of the NOL carryforward rules post-TCJA, suppose a company lost $5 million in 2022 and earned $6 million in 2023. Its carryforward limit for 2023 would be 80% of $6 million, or $4.8 million.

What are the rules for carry forward of losses? ›

Rules to carry forward losses:
SectionLosses can be carried forwardTime limitation for carry forward
73Loss from speculative business4 Years
73ALoss from specified businessNo time limit
74Short term capital loss8 Years
74Long term capital loss8 Years
3 more rows
Apr 12, 2024

What is an example of a net operating loss carryforward? ›

Imagine a company that had an NOL of $5 million one year and a taxable income of $6 million the next. The carryover limit of 80% of $6 million is $4.8 million. The full loss from the first year can be carried forward on the balance sheet to the second year as a deferred tax asset.

What is the logic behind allowing tax loss carryforwards? ›

Key Takeaways. Loss carryforwards are used to spread a current net operating loss (NOL) over subsequent years' net operating income (NOI) in order to reduce future tax liability.

How many years can you carry forward a loss on your taxes? ›

How Long Can Losses Be Carried Forward? According to IRS tax loss carryforward rules, capital and net operating losses can be carried forward indefinitely.

How do you calculate net operating loss deduction? ›

How to Calculate Net Operating Loss? On a business expense sheet, the net operating loss is calculated by subtracting itemized deductions from adjusted gross taxable income. If the result is a negative number, you have net operating losses. This is displayed on line 41 on Form 1040, U.S. Individual Income Tax Return.

Which loss Cannot be carried forward? ›

Losses from Non-speculative Business (Regular Business) Loss

Cannot be carried forward if the return is not filed within the original due date.

Do carried forward losses have to be used? ›

Individuals can generally carry forward a tax loss indefinitely, but must claim a tax loss at the first opportunity. You cannot choose to hold onto losses to offset them against future income if they can be offset against the current year's income.

What is the difference between carryover and carry forward? ›

Carryforward is moving unobligated funds from one year to a subsequent year. Carryover is synonymous with an offset, which reduces the total amount of federal funds obligated to date (“TAFFOD”) of the award by the amount of the unspent balance between years.

How do you explain net operating loss carryover? ›

A Net Operating Loss (NOL) Carryforward allows businesses suffering losses in one year to deduct them from future years' profits. Businesses thus are taxed on average profitability, making the tax code more neutral.

Can I use more than $3000 capital loss carryover? ›

The IRS caps your claim of excess loss at the lesser of $3,000 or your total net loss ($1,500 if you are married and filing separately). Capital loss carryover comes in when your total exceeds that $3,000, letting you pass it on to future years' taxes. There's no limit to the amount you can carry over.

What is the net loss formula example? ›

The net loss formula can be calculated by subtracting revenue from expenses. For example, if a company's revenue was $100 and its expenses were $60, the company would have a net loss of $40. Since there is a total cost of $350,000, then the net loss would be $400,000.

How do tax carryovers work? ›

If your capital losses for the year are greater than your capital profits, you can carry the unused losses forward to subsequent tax years. In those subsequent years, you can claim a capital loss carryover when you have capital losses that exceed your capital gains in that given tax year.

What is the 80% NOL rule? ›

The rules state that the amount of the NOL is limited to 80% of the excess of taxable income without respect to any § 199A (QBI), § 250 (GILTI), or the NOL. For example: In this example, tax is paid on $20,000 of income even though there was an NOL carryover more than the current year's income.

What is an example of a short term capital loss carryover? ›

Say you have a very bad year in the market. You sell stocks for a total gain of $10,000, but sell other stocks for a total loss of $15,000. You could deduct the first $10,000 of those losses from your capital gains, leaving you with no taxable capital gains for the year.

What qualifies as a capital loss? ›

A capital loss is the loss incurred when a capital asset, such as an investment or real estate, decreases in value. This loss is not realized until the asset is sold for a price that is lower than the original purchase price.

Can ordinary losses be carried forward? ›

Ordinary losses are fully deductible in the year losses were incurred and cannot be carried forward to subsequent years.

What do you mean by carry forward? ›

verb. (Accounting: Basic) If you carry forward a balance, you transfer it to the next page or column of an account, or to another ledger or book, so that it will be the starting figure there. This balance is carried forward from the previous page. Is the client's current balance carried forward to the next billing?

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