With the 2015 tax filing season in the rear-view mirror for most of us, it’s time to start thinking about 2016 income-tax planning if you haven’t done so already. The starting point for income-tax planning should always be your prior-year income-tax returns.
In addition to giving you a baseline for your projected 2016 income, deductions, and tax payments, your 2015 income-tax returns may contain hidden gems in the form of unused losses, deductions, or tax credits that must be carried forward to 2016. The burden is on you to identify, and remember to use, these items when you do your 2016 income tax planning and preparation. This article will briefly discuss five carryovers to remember as part of your 2016 tax planning.
Since 1978, there has been a limit of $3,000 on the amount of net capital losses than can be offset against ordinary income. The limit is reduced to $1,500 if you’re married and filing separately from your spouse. Net capital losses are calculated by offsetting net short-term (holding period of one year or less) gains or losses against net long-term (holding period of more than one year) gains or losses.
To the extent that the offset process results in a net loss, up to $3,000 is deductible on your current year tax return, with the excess carried forward to the following year. The excess loss needs to be distinguished between short vs. long term on your following year’s income-tax return. Unallowed capital-loss carryovers can be offset against future years’ capital gains and can be carried forward indefinitely.
Deductibility of losses from passive activities, including rental-property losses for non-real-estate professionals with modified adjusted gross income (MAGI) greater than $100,000 has been limited since 1986. Individuals with MAGI between $100,000 and $150,000 can deduct rental-property losses up to $25,000 ($12,500 for married filing separate), with the amount of the deduction reduced the greater your income. A passive activity is an investment in a trade or business in which the investor is not a material participant.
Passive losses, including rental-property losses that don’t qualify under the MAGI income limitations, are nondeductible unless (a) they can be offset against net income from other rental properties and other passive activities or (b) in the case of a rental property, there’s a complete disposition of the property to an unrelated party in a taxable transaction. Unallowed, or suspended, passive losses can be carried forward indefinitely.
If you borrow money for investment purposes, the interest you pay is considered to be investment interest. This type of interest is deductible up to the amount of net investment income provided that it’s not incurred to produce tax-exempt income in which case it’s nondeductible.
Investment income includes, but isn’t limited to, interest, dividends, capital gains, rent and royalty income, non-qualified annuities, and income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities. Net investment income equals investment income reduced by investment expenses. Unallowed investment interest, like unallowed capital losses and suspended passive losses, can be carried forward indefinitely.
Although it doesn’t come into play as often as the first three carryovers, there’s a limitation on the amount of charitable contributions that can be deducted in a single year. In general, contributions to charitable organizations may be deducted up to 50% of adjusted gross income (AGI). Contributions to certain private foundations are limited to 30% of AGI.
The limitation can apply in the year that a charitable remainder trust (CRT) is funded or when large donations are made to private foundations. Unlike the first three types of carryovers for which there’s an unlimited carryover time frame, any unallowed charitable contribution deduction can only be carried over and deducted in each of the next five years.
Net operating loss
A net operating loss (NOL) is the least-common type of carryover discussed in this article. In general, an NOL is the excess of one’s business deductions over business gross income.
Unlike the first four types of deductions which can only be carried forward, an NOL can be carried back two years before the NOL year with any remaining NOL carried forward up to 20 years after the NOL year. In addition, an election can be made to forego the carry back period. NOLs can be offset against taxable income in the carry back or carry forward years.
The five carryovers discussed in this article represent unused losses or deductions that originate in one or more years. The amount of each type of loss or deduction and associated income tax savings can be substantial. Given this fact, it’s important that you keep track of each type and amount of carryover and look for opportunities to use them in your tax planning each year.
An income-tax professional should be consulted when working with these hidden gems to ensure that they’re properly identified and calculated, determine when and how to best make use of them, and make certain they aren’t forgotten.
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.