When your 2014 individual tax returns were completed the focus was probably on the final numbers and the resulting refund or tax due amounts. Often times there are a certain deductions, losses, or credits that cannot be utilized in the current year tax returns and must be carried forward to future tax years. It is very important for you to know of these items and how they might impact your 2015 tax returns. It can be very important to share certain carryover information with other professional advisors who may be guiding decisions that will have an impact on your use of these carryover items in your future tax returns.
Many carryover items occur because of the various limitations that exist in the income tax rules and regulations. One of the most common carryover items is the net long-term capital loss. The limitation that governs this is you can only deduct $3,000 of net long-term capital loss against ordinary income each year. The amount of the net long-term capital loss in excess of $3,000 becomes a carryover to use first against capital gains in future years and second to offset ordinary income at a rate of $3,000 per year. The carryover period is unlimited. If you have suffered a net long-term capital loss in a prior year resulting in a carryover to use against future capital gains and $3,000 of ordinary income each year, it will be important to share this information with your stock broker or to consider it when you make investment decisions concerning sales of capital assets. If your stock broker does not know of your carryover situation he may be hesitant to sell an appreciated stock for fear of the tax consequences. However, if he is aware of your carryover he may in fact look for opportunities to sell stocks to realize gains and utilize the carryover. Be sure to look at your 2014 tax return and the information reported on schedule D to determine if you have a net capital loss carryover. If you do have a carryover, be sure to share this information with your investment advisor.
Another common carryover item is a passive activity loss (PAL) from a rental activity. If you own rental real estate and the net result is a loss, there is a good chance you will not receive a current deduction. The loss will be suspended and carried over to future years to offset any future passive activity income (PAI). The PAL is held in suspension to a future year when you either have PAI or when you dispose of the real estate rental. In the year of PAI you will be able to use the carryover to offset PAI. In the year of disposal you will be able to deduct the full amount of the suspended losses that have been carried over and accumulated during the years you have owned the property. It is important to work closely with your CPA if you have a carryover PAL and you are expecting to sell the property that has caused the carryover. Let you CPA know that you plan to sell the rental property so that the overall tax impact can be measured. Because the losses that will be available to you in the year of sale may have been the cumulative result of several years of rental results, it will be important to do some serious tax planning to see what other impact this will have on your overall return. I am currently working with a client who is trying to sell a rental property with a suspended loss that has accumulated over several tax years. Because this loss will offset so much of his ordinary income in the year of sale, he will be able to use the zero percent tax bracket for some of the capital gain resulting from the sale.
I mentioned that limitations contained in the tax code can lead to carryovers. If you make charitable contributions in excess of the 50% or 30% or 20% AGI limitations, the excess provides a carryover. This carryover is available to be used in the succeeding five years and then it expires. Also, the carryover is only available after first deducting the charitable contributions made in the current year. Because the carryover is only used after the current year donations, it can present a planning challenge to utilize it during the five carryover years. One of the planning considerations in this carryover situation is to actually plan income to give room for the deduction since the limitation is based on AGI. We have worked closely with other financial advisors during the 5-year carryover period to encourage the recognition of investment income (interest and dividends) subject to tax and discourage recognition of investment income that is exempt from income tax (muni bonds), thus increasing AGI which is the calculation base for the percentage limitation. So, again this is a situation where it is important to coordinate the knowledge and experience of your collective financial advisors (CPA and stock broker).
The final carryover item I want to mention is investment interest expense. Investment interest is interest on debt allocable to property held for investment. The limiting factor in this case is that investment interest is only deductible (as an itemized deduction) to the extent of investment income recognized in the same tax return. In this case, investment income is interest income and non-qualifying dividends. Again, planning coordination with your CPA and financial advisor can lead to the use of this carryover item and overall tax reductions. The type of investment income will be important to be able to soak up this carryover deduction.
In conclusion, I want to point out that a current deduction is worth a lot more than a carryover. Coordinate your tax planning efforts with the input from your CPA and your financial advisor. Review your latest tax return and ask your CPA about any carryover items. Arrange for a round table discussion involving your CPA, financial advisor, and estate planning attorney and use your most recent tax return as the center point of discussion.