Capital Loss Carryovers
There are many misconceptions about capital-loss carryovers.
Many traders mistakenly think they can only utilize $3,000 of capital loss carryovers each year going forward, so they worry it can take a lifetime to use up these losses. They don’t realize they can also offset capital losses without limitation against subsequent year capital gains, which means if they make money trading — remaining in capital gains treatment rather than electing Section 475 MTM treatment — they can use these losses. The $3,000 limitation is against non-capital gains income, not capital gains.
Some traders mistakenly think individually generated capital loss carryovers incurred before trading in a new pass-through trading entity is going to be lost. The new entity can forgo a Section 475 election and pass through capital gains on a Schedule K-1 from the entity to individual tax returns (Schedule D), where they are offset by individual capital-loss carryovers. A new entity is the best way to climb out of a capital loss carryover hole. Before the 475 election internal resolution is due within 75 days of entity inception, if the entity has capital gains, skip the 475 election to soak up capital loss carryovers. Conversely, if the entity has large new trading losses in those first 75 days, have the entity elect Section 475 for ordinary loss treatment. The entity can then revoke Section 475 in the subsequent year to get back to capital gains treatment to soak up capital loss carryovers.
Using up capital-loss carryovers is a challenge for many traders. Proper Section 475 MTM election planning and entities are the answer. It pays to think out the nuances carefully and not make a blanket decision to skip Section 475 as that can cost you big time!
Learn more about capital loss carryovers and how best to utilize them in Green’s 2017 Trader Tax Guide.