This article should be cited as:
What is it? Does it apply to me?
The Net Operating Loss, in the U.S. Tax Code, as applied to individuals and small businesses, and it's provisions for carry back and carry forward are exceedingly complex. Turbotax does not adequately address this feature, in fact they don't even include Form 1045. The best they accomplish toward it, is confusing and contradictory instructions and the unhelpful entry box "Net operating loss available to carry forward". The only explanations given in the program, for how to calculate this, are inadequate. Most parts of Turbotax are very good, but on this part, they fall face down. Why? Because, nobody can understand Form 1045.
Note: This article only addresses these issues for individuals and small businesses, and neither for corporations, nor for trusts.
IRS Publication 536 addresses certain aspects of the Net Operating Loss. The very important first step being the question, "Do I have a Net Operating Loss that I can carry forward or carry back?" The simplest answer is to look at your prior year's Income Tax Return. For individuals who filed using Form 1040NR, look at line 38, for individuals who filed using Form 1040, look at line 41. If the amount shown there, on your return, is not negative, then you do not have a Net Operating Loss. Stop. Leave. You're done.
If it is negative, then you may have a Net Operating Loss. The reason that I here say "may" and not "do", is because that line of your tax return includes items which are not allowed when calculating your Net Operating Loss. So let's take a moment to ponder this question, "What does it mean to have a loss, have it be net, and have it be operating?"
You have a Net Operating Loss, if you have businesses which for that year, spend more money than they take in. That is, your expenses exceed your income for your businesses for that year. By "operating" the I.R.S. essentially means an "active" as opposed to a "passive" loss. This distinction is related to Schedule C versus your other schedules. In order to have an active loss versus a passive loss, you must have filed a Schedule C. Losses on Schedule D, and losses on Schedule E cannot be carried back. They are called suspended losses, and must be carried forward. They are not part of any "Net Operating Loss" because they are passive losses.
You cannot calculate your Net Operating Loss by simply looking at your Schedule C. This is because there are items which go into the Net Operating Loss calculation which do not appear on Schedule C, but rather in other places in your return. There is no place in fact, anywhere in your return, where you can simply "get the answer", this is because the opposite is also true. Some figures in your return include amounts which are not allowed as part of your Net Operating Loss calculation. So the calculation itself requires a new special worksheet, or a bunch of figuring it out on a piece of scratch paper.
"Net Operating Loss Carryforward" by Will Johnson, wjhonson@aol.com at knol.google.com
Creative Commons Attribution 3.0 License
Creative Commons Attribution 3.0 License
Some online resources related to this topic
- IRS Publication 536, Net Operating Losses
- IRS Instructions for Form 1045 (HTML format)
- IRS Form 1045
What is it? Does it apply to me?
The Net Operating Loss, in the U.S. Tax Code, as applied to individuals and small businesses, and it's provisions for carry back and carry forward are exceedingly complex. Turbotax does not adequately address this feature, in fact they don't even include Form 1045. The best they accomplish toward it, is confusing and contradictory instructions and the unhelpful entry box "Net operating loss available to carry forward". The only explanations given in the program, for how to calculate this, are inadequate. Most parts of Turbotax are very good, but on this part, they fall face down. Why? Because, nobody can understand Form 1045.
Note: This article only addresses these issues for individuals and small businesses, and neither for corporations, nor for trusts.
IRS Publication 536 addresses certain aspects of the Net Operating Loss. The very important first step being the question, "Do I have a Net Operating Loss that I can carry forward or carry back?" The simplest answer is to look at your prior year's Income Tax Return. For individuals who filed using Form 1040NR, look at line 38, for individuals who filed using Form 1040, look at line 41. If the amount shown there, on your return, is not negative, then you do not have a Net Operating Loss. Stop. Leave. You're done.
If it is negative, then you may have a Net Operating Loss. The reason that I here say "may" and not "do", is because that line of your tax return includes items which are not allowed when calculating your Net Operating Loss. So let's take a moment to ponder this question, "What does it mean to have a loss, have it be net, and have it be operating?"
You have a Net Operating Loss, if you have businesses which for that year, spend more money than they take in. That is, your expenses exceed your income for your businesses for that year. By "operating" the I.R.S. essentially means an "active" as opposed to a "passive" loss. This distinction is related to Schedule C versus your other schedules. In order to have an active loss versus a passive loss, you must have filed a Schedule C. Losses on Schedule D, and losses on Schedule E cannot be carried back. They are called suspended losses, and must be carried forward. They are not part of any "Net Operating Loss" because they are passive losses.
You cannot calculate your Net Operating Loss by simply looking at your Schedule C. This is because there are items which go into the Net Operating Loss calculation which do not appear on Schedule C, but rather in other places in your return. There is no place in fact, anywhere in your return, where you can simply "get the answer", this is because the opposite is also true. Some figures in your return include amounts which are not allowed as part of your Net Operating Loss calculation. So the calculation itself requires a new special worksheet, or a bunch of figuring it out on a piece of scratch paper.
A special note for Stock Market investors (and other Schedule D losses)
Losses on Schedule D, which exceed your limitation, or where you otherwise have a negative net income for that year, must be carried forward. They are called suspended losses. You carry them forward, applying them to future Schedule D gains until used up. A special note for Real Estate Investors
It is time here to totally confuse you and send you screaming from the room. We need to touch on "Rental property loss". Rental Property Income and Expenses, are reported on Schedule E Supplemental Income and Loss. You have a Real Property Loss, if the bottom of your Schedule E shows a negative amount. This is not considered a business expense, unless you are a real estate professional - that is, a person who basically earns most of their money through real estate, and is self-identified as a real estate agent, realtor, etc. Don't try to fool the system here. Real estate investments, for the rest of us, are generally considered a passive activity. Special rules apply to using this amount in a carryforward. We will get to that in a bit.
I do however, want to address a few particular points right now, as I know you are anxious to know these answers. As you probably already know, you can apply "passive activity losses" to your regular active income, in the year in which those passive activity (real estate) losses actually occurred. This benefit is limited to $25,000 and is also only able to be fully-utilized by "middle-income" earners, gradually disappearing as your income rises higher. So if your real estate holdings, in total, generated a net loss of $8,000 but you also have income of $35,000 from other activities, active or passive, you can reduce your $35,000 to only $27,000 with this $8,000 loss. However, and please note carefully, if you can not use the total loss in the year in which it occurred, then it becomes what is called a suspended loss. A suspended loss, is not the same thing as a Net Operating Loss that you can carry forward and apply against any ordinary income. Suspended losses can be carried forward, but may solely be applied to other passive activity gains until such time as you completely dispose of that real estate, or use up the loss completely. That is, when you sell, you can then apply any remaining built-up suspended losses against the gain of your real estate sale. If you had no gain at all, or if you zeroed out your gain against your suspended losses and still have more suspended losses, you may then apply all those left-over suspended losses against any other ordinary income whatsoever without limit. Note that you do not need passive activity income from the particular property that generated the previous suspended loss, you can apply the suspended loss against any passive activity income. You just cannot apply the suspended loss against active activity income any longer. Until you sell. Confused yet?
I read on another tax advice board, the expert stating that you could apply $25,000 of your suspended losses each and every year against ordinary income. This is not so. You can only apply $25,000 of your current passive activity losses against ordinary income - that is, passive activity loss you actually incurred in that tax year. Suspended losses (which are prior year losses) may only be applied against passive activity income in that year, until you dispose of the property.
If this article has helped you so far, click here to leave a five dollar donation in my beer and chip fund to keep research like this going.
Continue on to Page Two: Calculating your Net Operating Loss (beware, here be dragons)
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
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It is time here to totally confuse you and send you screaming from the room. We need to touch on "Rental property loss". Rental Property Income and Expenses, are reported on Schedule E Supplemental Income and Loss. You have a Real Property Loss, if the bottom of your Schedule E shows a negative amount. This is not considered a business expense, unless you are a real estate professional - that is, a person who basically earns most of their money through real estate, and is self-identified as a real estate agent, realtor, etc. Don't try to fool the system here. Real estate investments, for the rest of us, are generally considered a passive activity. Special rules apply to using this amount in a carryforward. We will get to that in a bit.
I do however, want to address a few particular points right now, as I know you are anxious to know these answers. As you probably already know, you can apply "passive activity losses" to your regular active income, in the year in which those passive activity (real estate) losses actually occurred. This benefit is limited to $25,000 and is also only able to be fully-utilized by "middle-income" earners, gradually disappearing as your income rises higher. So if your real estate holdings, in total, generated a net loss of $8,000 but you also have income of $35,000 from other activities, active or passive, you can reduce your $35,000 to only $27,000 with this $8,000 loss. However, and please note carefully, if you can not use the total loss in the year in which it occurred, then it becomes what is called a suspended loss. A suspended loss, is not the same thing as a Net Operating Loss that you can carry forward and apply against any ordinary income. Suspended losses can be carried forward, but may solely be applied to other passive activity gains until such time as you completely dispose of that real estate, or use up the loss completely. That is, when you sell, you can then apply any remaining built-up suspended losses against the gain of your real estate sale. If you had no gain at all, or if you zeroed out your gain against your suspended losses and still have more suspended losses, you may then apply all those left-over suspended losses against any other ordinary income whatsoever without limit. Note that you do not need passive activity income from the particular property that generated the previous suspended loss, you can apply the suspended loss against any passive activity income. You just cannot apply the suspended loss against active activity income any longer. Until you sell. Confused yet?
I read on another tax advice board, the expert stating that you could apply $25,000 of your suspended losses each and every year against ordinary income. This is not so. You can only apply $25,000 of your current passive activity losses against ordinary income - that is, passive activity loss you actually incurred in that tax year. Suspended losses (which are prior year losses) may only be applied against passive activity income in that year, until you dispose of the property.
If this article has helped you so far, click here to leave a five dollar donation in my beer and chip fund to keep research like this going.
Continue on to Page Two: Calculating your Net Operating Loss (beware, here be dragons)
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.
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