Calculating Your Net Operating Loss

When, where, and how to calculate this monster

The Net Operating Loss, as applied to individuals and small businesses, is one of the most complicated features of the U.S. Tax Code, perhaps second only to the calculation of recaptured depreciation. The IRS does not explain it clearly. In fact, I have found no resource which explains it clearly, that is why I created this article. This is Page Two, of a multi-page article which will investigate the Net Operating Loss calculation.


<-- Return to Page One: Net Operating Loss Carryforward
--> Continue on to Page Three: Calculating Your Net Operating Loss (Page Three)

This article should be cited as:
"Net Operating Loss Carryforward : Calculating Your Net Operating Loss (Page Two)" by Will Johnson, at Creative Commons Attribution 3.0 License


Some online resources related to this topic

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In page one of this multiple-page article Net Operating Loss Carryforward, I discussed what a Net Operating Loss is, and how it can be used to reduce your taxable income on your U.S. 1040 Tax Return.  This multiple-page article applies to individuals and small businesses, and neither to corporations nor to trusts.

In this second page of the multiple-page article, we will start looking at the details of exactly how you calculate your Net Operating Loss.

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.

Do I need to file Form 1045?

Some people who have established that they do, in fact, have a potential Net Operating Loss, wish to apply such a loss to a prior year's return, in order to get a refund (or possibly to reduce an amount owed).  You can file form 1045 to do this.  However, it may be more advantageous to carry your loss forward, instead of back. For one thing, it's simpler.  For another, you may expect more income in the future than you had in the past.  If you choose to carry your loss forward, you do not need to file any additional form, instead the carryforward amount gets  reported on your normal income tax return.  And we will get to where on your return you put this later.  Right now we want to discuss more how to calculate your loss.

Some people, even if they don't have a requirement to file Form 1045 (because they are not carrying back), still like to use it, just for their own records, to remind themselves how they calculated their carry forward amount.  If you do not have a requirement to file Form 1045, because you are not carrying back, do not file it.  Fill it out and stick it in your own file cabinet.  Use it simply as your own worksheet if you wish.

Form 1045 is a four-page form, the second page of which is called "Schedule A".  This should not be confused with the Schedule A that is part of your Form 1040, they are different things.  Form 1045 Schedule A goes into mind-numbing complexity about how to calculate your carry amount, which you will then either carry back or carry forward.  It will take you 11 hours to understand the form, and another hour to fill it out.  When you are done, the I.R.S. will hire you.

So let's see if we can turn your potential Net Operating Loss, into a real Net Operating Loss, or show you that you do not in fact have a Net Operating Loss at all.  To do that we will go through Form 1045 Schedule A line-by-line.  If you go insane, please call 911 and have yourself committed.  And don't blame me, blame the I.R.S.

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election to waive

"If you choose to carry your loss forward, you do not need to file any additional form, instead the carryforward amount gets reported on your normal income tax return."

This might be a good place to mention (or repeat) that you would be required to file a statement of "election to waive IRC Section 172 (b) (3)" to be included in your return for this year's NOL.

Also, for clarification, the carryforward get's reported on "future" years' returns.

Anonymous - 16 Apr 2011

I think you're right if you're only meaning what Schedule A-NOL refers to as "Business capital losses" (line 11). But in my case and I'd presume others', my K-1 nonpassive loss (income loss) from K-1 box 1, (reported on Schedule E, column h, and 1040 line 17) is the bulk of my 1040 line 38 hence Schedule A-NOL, line 1.

Anyway, you're right, this NOL stuff has got to be the most in-cohesive part of the whole code.

Anonymous - 16 Apr 2011

Yes exactly. Your 2009 NOL gets reported on your 2010 1040 on the front page as a negative number under Other Income.

As to your other question about carrybacks on Schedule E, my own understanding of this is that any losses on D or E must be carried forward as suspended losses. That is, they cannot be carried back no matter how they were created. Only losses on Schedule C can be carried back.

I cannot be certain that I am right in that Schedule E issue, but it's my understanding of it.

Will Johnson - 15 Apr 2011