IRC 1212: Capital Loss Carryback and Carryover Rules

The tax code allows taxpayers to use capital losses that exceed the annual deduction limit. When investment losses are greater than this limit, the excess amount is not forfeited but can be moved to other tax years to offset income. This process is governed by Internal Revenue Code (IRC) Section 1212, which outlines the rules for capital loss carrybacks and carryovers. These provisions differ significantly for individuals and corporations.

Capital Loss Carryover Rules for Individuals

When an individual’s capital losses exceed their capital gains, they can deduct up to $3,000 of the excess loss against other types of income, such as wages. For married individuals filing separate returns, this annual limit is $1,500. Any remaining capital loss can be carried forward to subsequent tax years indefinitely until the entire amount is used.

The character of the loss, as either short-term or long-term, is preserved in future years. Short-term losses are first used to offset short-term gains, and long-term losses are first applied against long-term gains. This allows for strategic tax planning before losses are used against other income.

For example, if a taxpayer realizes a $15,000 long-term capital loss and has no capital gains, they can deduct $3,000 of that loss against their ordinary income. The remaining $12,000 is carried forward to the next year as a long-term capital loss. In the following year, that $12,000 carryover would first be used to offset any long-term capital gains, then short-term gains, and finally, up to another $3,000 could be deducted against ordinary income.

Capital Loss Carryback and Carryover Rules for Corporations

The rules for C corporations are distinctly different from those for individuals. Unlike individuals, corporations cannot use capital losses to offset their ordinary business income. Corporate capital losses can only be used to offset corporate capital gains.

When a corporation’s capital losses exceed its capital gains, it must first carry the net capital loss back to the three preceding tax years. However, a loss cannot be carried back if doing so would create or increase a net operating loss for that year. If the loss is not fully absorbed, it can then be carried forward for up to five years, applied to the earliest year first.

Another difference is the treatment of the loss’s character. Regardless of whether the original loss was short-term or long-term, it is always treated as a short-term capital loss when carried back or forward.

To initiate a carryback, a corporation can file Form 1139, Corporation Application for Tentative Refund, or an amended return on Form 1120-X. Filing Form 1139 typically results in a faster refund, as the IRS is generally required to process these applications within 90 days.

Calculating and Reporting Capital Loss Carryovers

For individual taxpayers, capital losses and their carryovers are handled on Schedule D, Capital Gains and Losses. A short-term carryover from a prior year is entered on line 6, and a long-term carryover is entered on line 14.

The form guides you through netting your current year gains and losses with any carryover amounts. Line 21 of Schedule D determines the deductible amount for the year.

To determine the exact amount and character of the loss to be carried forward, taxpayers must use the Capital Loss Carryover Worksheet from the IRS Instructions for Schedule D. This worksheet is not filed with the return but is a necessary tool for accurate record-keeping.

Corporations also use a Schedule D attached to their main income tax form, such as Form 1120, to report capital gains and losses.

When a corporation files for a tentative refund from a loss carryback, it must show the computation of the decrease in tax for the prior years. This involves reporting the income and tax figures from the prior years both before and after applying the loss. If filing an amended return on Form 1120-X, the corporation must similarly recalculate the tax for the prior year.