Capital Loss Carryovers - Are They Cash Flow?
A Schedule D shows a short-term capital loss carryover of ($121,000) on line 6 and a long-term capital loss carryover of ($374,000) on line 14. However, only ($3,000) of those total losses carries to Form 1040 line 7 due to the capital loss limitation rules. Which of these values should be included in your calculation of the borrower’s cash flow?
None of those amounts should be included in cash flow! A banker, whose borrower has the above Schedule D, called into the Bukers Hotline thinking that her borrower had horrendous cash flow issues. The sum of the capital loss carryovers totaled ($495,000) which nearly doubled her borrower’s $250,000 salary. The banker thought she shouldn’t do business with this borrower since the losses offset salary resulting in a “net” negative of ($245,000). The banker is wrong here.
The capital loss carryovers are merely “paper” loss carryovers and should be ignored in a cash flow analysis. The total capital loss carryover of ($495,000) represents capital losses that were incurred in prior years by the borrower. Tax law limits the amount of capital losses that an individual can actually deduct on their tax return.
What Are Capital Loss Carryovers and How Do They Work?
First, capital losses will offset capital gains. If capital losses exceed capital gains, up to $3,000 of the loss can be carried to page 1 of the Form 1040 to offset ordinary income. The excess capital losses can then be carried over to subsequent years, for an unlimited time, until the total loss is exhausted. The capital loss carryovers reported on lines 6 & 14 of the Schedule D equal the amount of capital losses that have not yet been deducted on the individual’s tax return. For this reason, capital loss carryovers are not a cash event and should not be included in the calculation of total cash flow.
Looking For More?
For a more in-depth analysis of how capital losses affect your spread of a borrower’s tax return, look at our Bukers Taxanalysis Self-Study course. As always, users of the Bukers Taxanalysis and BTA Pro software can call into the Bukers Hotline with any tax return related questions just like the question above.