What Is a Tax Loss Carryforward?

What Is a Tax Loss Carryforward?

Let me explain what a tax loss carryforward is. It's an IRS provision that lets you, whether you're a business or an individual, take a tax loss from one year and apply it to future years to offset part of your taxable income.

Key Takeaways

You can use a tax loss carryforward to apply a loss from one year against income in future years. Remember, there are two types: net operating loss (NOL) carryforwards, which apply to businesses, and capital loss carryforwards, which can apply to businesses or individuals but with different rules.

Net Operating Loss (NOL) Carryforwards

A company's net operating loss (NOL) can offset part of its taxable income in future tax years through this IRS carryforward provision. These carryforwards are capped at 80% of each subsequent year's net income. If your company has negative net operating income in year one but positive in years two and three, you can use the NOL carryforward to cut taxable income in those later years.

This provision gives you tax relief when your company loses money in a specific tax period. Take a tourism business, for example—it's affected by weather and might have profits and a big tax bill one year, an NOL the next, and then another profitable year. To even out the tax burden, the loss carryforward lets you apply the NOL from the second year against taxes in the third.

Here's an example: suppose your company lost $5 million in 2023 and earned $6 million in 2024. The IRS sets your carryforward limit in 2024 at 80% of $6 million, which is $4.8 million. That reduces your 2024 taxable income to $1.2 million ($6 million minus $4.8 million). The leftover $200,000 NOL ($5 million minus $4.8 million) can carry forward to 2025 or later, whenever you turn a profit again.

Important Changes from the Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (TCJA) of 2018 changed the rules. Previously, businesses could carry NOLs forward 20 years or back two years for a refund on past taxes. Now, the two-year carryback is gone except for certain farming losses, and carryforwards are indefinite but limited to 80% of each year's net income.

Capital Loss Carryforwards

When you sell capital assets like stocks, bonds, industrial equipment, or real estate, you get capital gains or losses based on the difference between the selling price and the tax or cost basis—usually the purchase price plus improvements minus depreciation. A higher selling price means a gain; lower means a loss.

Both companies and individuals can use capital loss carryforwards. For corporations, these losses only offset capital gains. You can carry them back starting three years prior, then two, then one, and if anything's left, forward for five years.

For individuals, net capital losses can offset ordinary income up to $3,000 per tax year, or $1,500 if married filing separately. Anything over that carries forward. Say you sold 1,000 shares of XYZ stock for $10,000 less than your cost basis, that's a $10,000 loss. If you also had a $2,000 gain from other stock, your net loss is $8,000. You can deduct $3,000 this year, and carry the remaining $5,000 forward to offset $3,000 next year, leaving $2,000 for the year after.

How Is the Cost Basis of a Stock Determined?

The cost basis of a stock is typically what you paid for the shares, plus any reinvested dividends. You can also add commissions or fees from the transactions. If you inherited the stock, the basis is its value at the time the original owner died.

What Is Tax Loss Harvesting?

Tax loss harvesting is a strategy where you sell an investment at a loss, replace it with something similar in your portfolio, and use the capital loss to offset gains or other income. It's legal, but watch out for wash sale rules—you can't buy a substantially similar security within 30 days of the sale.

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

State laws on NOL carryforwards differ. Some match federal rules, others have their own caps or time limits. The same goes for capital loss carryforwards at the state level.

The Bottom Line

You'd rather have profits than losses, but losses do offer one benefit: using them to offset gains, even years later, via carryforwards. This IRS provision provides tax relief for losses in a given period, whether for your business or personally.