Preserving Capital Loss Carryovers

Posted by Lee Reams Sr. on

The question frequently arises whether or not an individual must file a return, even if not otherwise required to file, in order to preserve a capital loss carryover.

In reading the IRS instructions, it appears the answer is no based upon the following statement that appears in both IRS Publications 550 (Pg. 69) and 17 (Pg. 117):

“When you figure the amount of any capital loss carryover to the next year, you must take the current year's allowable deduction into account, whether or not you claimed it and whether or not you filed a return for the current year”.

However, to claim a capital loss carryover the Schedule D instructions indicate the taxpayer needs a copy of their prior year 1040 and Schedule D to complete the capital loss worksheet to determine how much loss is carried forward from the prior year.     

In figuring the carryover, the amount of the capital loss carryover is the amount of taxpayer’s total net loss that is more than the lesser of the taxpayer’s:

  1. Allowable capital loss deduction for the year (3,000), or
  2. Taxable income increased by the taxpayer’s allowable capital loss deduction for the year and the taxpayer’s deduction for personal exemptions.

Bottom line, there appears there is no actual requirement to file a return, where one is not otherwise required to be filed. However, since the carryover is based upon the results of a prior year return, the taxpayer would have to be able to reconstruct the prior year return to prove the carryover if challenged on the amount of the carryover.

Best Practice: That leads us to believe that the best practice may be to actually file a return and run the statute of limitations even though it is not actually required.