Speaking broadly, you may be able to benefit by carrying what is called a “net operating loss” (NOL) into a different year — a year in which you have taxable income — and taking a deduction for it against that different year’s income. This would be known as taking a net operating loss deduction (NOLD). In general, the loss can be carried back 2 years and forward for up to 20 years to “seek out” taxable income against which it will be deducted. (A somewhat complicated IRS form must be filed to carry back a net operating loss. If you would like more information on how to take the NOLD back or forward, consult your tax professional.)

In determining what your net operating loss is, however, you don’t simply use your negative taxable income off your tax return. Several modifications must be made. These include the following:

 (1) You cannot use your personal or dependency exemptions.

 (2) You cannot use any NOLD from a different year.

 (3) “Nonbusiness” capital losses (those arising outside of your trade or business) can only be used against “nonbusiness” capital gains. Excess losses cannot increase your NOL.

 (4) “Nonbusiness” deductions (e.g., charitable donations, deductible medical expenses, mortgage interest, alimony, etc.) can only be used against “nonbusiness” income (interest, dividends, etc.). That is, they cannot directly increase your NOL.

However, if you have nonbusiness capital gains in excess of nonbusiness capital losses (see (3), above), you can use your “excess” nonbusiness deductions against these gains. (Note that casualty losses are treated as fully useable “business deductions” for these purposes.)

 (5) Finally, “business” capital losses can only be used against “business” capital gains, except that if you still have nonbusiness capital gains after netting nonbusiness capital losses and excess nonbusiness deductions against them, you can use your business capital losses against them.

Obviously, the above computations can grow quite complex, depending upon your particular circumstances. Please call if you would like us to work out any calculations for you.

 Example. Ned has a loss of $20,000 from his business operations for the year. He also has (i) nonbusiness capital gains of $9,000 and nonbusiness capital losses of $4,000, and (ii) nonbusiness income of $13,000 and nonbusiness deductions of $14,000 (not including personal or dependency exemptions). He has no business capital gains or losses.

Ned’s “starting point” for his NOL is his $20,000 business loss. His capital losses reduce his capital gains to $5,000 ($9,000 minus $4,000). His nonbusiness deductions wipe out his nonbusiness income and the $1,000 “excess” nonbusiness deductions ($14,000 − $13,000) further reduce the capital gains to $4,000. However, these $4,000 of capital gains do reduce Ned’s NOL from $20,000 to $16,000.

The final result: Ned incurs a $16,000 NOL for the tax year. (Note: Ned’s taxable income will show a larger loss because of the modification rules, e.g., his taxable income includes his personal exemption. Only the $16,000 NOL, however, can be carried to other years for use as an NOLD.)

These rules are IRS rules. California NOL rules vary.