Legal Definitions - loss carryover

A loss carryover, also known as a loss carryforward, is a tax provision that allows individuals or businesses to use a financial loss incurred in one tax year to reduce their taxable income in future tax years. This mechanism helps taxpayers manage the impact of significant losses by spreading the tax benefit over time, rather than losing the benefit if they have no income to offset in the year the loss occurred. It essentially defers the tax deduction for a loss until there is sufficient income to apply it against.

It's important to note that only "realized" losses qualify. This means the loss must have actually occurred, for example, by selling an investment at a lower price than it was purchased, rather than simply experiencing a decrease in an asset's market value that hasn't yet been sold.

Here are some examples to illustrate how loss carryover works:

• Small Business Startup: Imagine a new tech startup, Innovate Solutions Inc., which spends heavily on research, development, and marketing in its first two years. In Year 1, the company has $500,000 in expenses and only $100,000 in revenue, resulting in a $400,000 net operating loss. In Year 2, it incurs another $300,000 loss. In Year 3, the company successfully launches its product and generates $600,000 in profit. Without loss carryover, Innovate Solutions Inc. would owe taxes on the full $600,000 profit. However, using the loss carryover provision, the company can use the accumulated $700,000 loss from Years 1 and 2 to offset its Year 3 profit. This reduces its taxable income to zero for Year 3, and the remaining $100,000 loss can be carried forward to future profitable years. This demonstrates how a business can use past losses to reduce future tax burdens.

• Individual Stock Investor: Consider Sarah, an individual investor who purchased shares in a promising biotechnology company. Unfortunately, the company's drug trials fail, causing its stock price to plummet. In 2023, Sarah decides to sell her shares for $20,000, which she had originally purchased for $70,000, resulting in a $50,000 capital loss. Tax regulations typically allow individuals to deduct a limited amount of capital losses against ordinary income each year (e.g., $3,000), with any remaining loss eligible for carryover. If Sarah has no capital gains in 2023 and can only deduct $3,000 against her ordinary income, she has $47,000 of her capital loss remaining. This $47,000 becomes a loss carryover. In 2024, if Sarah realizes $10,000 in capital gains from selling other investments, she can use $10,000 of her carried-over loss to offset these gains, reducing her taxable capital gains to zero. She can continue to carry forward the remaining loss until it is fully utilized or expires according to tax regulations.

• Real Estate Development Project: A real estate development company, Urban Sprawl Developers, completes a new commercial building project. Due to an unexpected downturn in the local economy and a sudden decrease in demand for office space, they are forced to sell the property for $8 million, even though their total cost of acquisition and development was $10 million. This results in a $2 million loss. If Urban Sprawl Developers has no other profitable projects in that tax year to offset this substantial loss, they can utilize the loss carryover provision. This allows them to carry forward the $2 million loss to future tax years. For instance, if in the following year they complete another project that generates $1.5 million in profit, they can use $1.5 million of the carried-over loss to reduce their taxable profit to zero, effectively deferring their tax liability until they have fully utilized the loss.