Tax Tip 195: How long can Tax Losses be carried forward?

Discussion in 'Accounting & Tax' started by Terry_w, 7th May, 2019.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    There is no time limit as to how long you can carry forward losses – whether income losses or capital losses, however they will be lost at death (a loss lost!). So, it makes sense that you should try to use up losses as early as possible. This is generally not too hard with income losses as these are easily eaten up the next financial year with more income being earned.

    Using up capital losses tends to be more difficult though as a capital loss can only be used up by a capital gain – not general income.

    Note that there are complex rules regarding companies and trusts in carrying forward losses.


    Example

    Homer invested money in a business he ran which failed. He lost $200,000 and has a $200,000 capital loss which he has been carrying forward for 9 years now. Homer would love to use this loss up, but the trouble is he has no other asset he could sell to offset the loss.

    If Homer owned shares for example he could sell shares with a $200,000 capital gain and not have to pay any tax.

    But losing his money has meant that Homer doesn’t have any capital to invest with.

    However, Homer’s daughter Lisa knows a thing or two so sets up a discretionary trust to hold investments. It could be possible that in future a gain from the trust could be distributed to Homer and his loss could offset this gain so that no tax is payable.
     
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  2. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    One common mistake with carrying forward income tax losses is this one:

    In 2010 through to 2017 Jenny is non-resident and her IP losses have accumulated in her absence. Her loss is $18,500.

    In July 2017 Jenny returned to Australia and earned $14,000. No tax was withheld.

    Does Jenny need to lodge ? Yes
    What is Jenny's 2018 taxable income ?? Her $14K earning are first reduced by the losses BEFORE any tax free threshold is considered. her taxable income is zero. BUT her losses are now $4,500.


    Losses must be used PRIOR to tax free thresholds. If Jenny earned even $100 she must reduce her losses.
     
    Last edited: 7th May, 2019
  3. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Second common mistake concerns carried forward capital losses. These can ONLY be used to offset capital gains. But it comes with a catch and its quite common for DIY taxpayers. It can result in penalties.

    Jim has $12,000 of carried forward capital losses. In August 2017 Jim sold his CBA shares and made a discounted capital gain. His total profit was $20,000

    1. Jim must FIRST reduce the $20K by the carried forward losses; and then
    2. Jim can only then apply the 50% CGT discount to the final gain ie $20K-$12K = $8k x50%/ Therefore $4k is taxed.


    Many people think that the formula is to determine the discounted capital gain (ie $10K and then reduce this by the loss of $10K) so that Jim has a carried forward loss still available of $2k.

    Thats not correct.
     
  4. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    Third common mistake. Discretionary trusts cannot distribute a loss. They can. It can be a CGT loss but not an income loss but some income losses can sometimes be distributed. Its quite complex and unless a tax adviser knows trusts and tax law well they commonly get it wrong. I have had to fix two new clients prior year tax for this very issue.

    Its a issue often requiring tax advice as there are traps. ie a Family Trust election maybe ? Resolution sand its commonly a issue for streaming to a specific beneficiary.

    Q : Can a Disc Trust with rental losses distribute a tax loss.? Unlikely. However if the trust has other forms of income its possible.
     
  5. Mike A

    Mike A Accountant Business Member

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    I wouldnt define it as distributing a loss from the trust. Better phrased as utilising losses in the trust.
     
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  6. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    There is a way a trust can distribute a loss. I did say its complex. Its actually reported that way in the tax return for the trust...

    The key catch is the trust must have $1 of net trust income to distribute. Then the various categories of distribution can include a loss in one category and income in another. In the trust tax return the Distribution Statement Item 55 includes labels for that purpose beside each category of income - a box where you can enter "L". I find accountants using some brands of tax software (MYOB products were poor at it) dont cater for the issue and when completing the distribution statement manually it seems illogical but is correct. Our Handitax does it automatically.

    eg Non-PP trading loss $10000, CGT gain $1,000 and Franked distributions $10,000. Net income = $1,000

    The beneficiary may (or may not) be able to utilise that loss. eg the non-pp loss could be a share of net rental losses together with franked investment income etc. Thats a common example.

    I just found a new client where the former tax agent didnt have a clue and they retained the loss element in the trust rather than pass it through as a element of net income. As a consequence the taxpayers overpaid tax. Not only that they made a fatal error in addressing that loss that net trust income in the accounts was then inconsistent with tax.

    All reasons why I recommend experienced practitioners in trusts as some tax advisers dont know trusts well. I count Mike in this group - He knows trusts well.
     
  7. kierank

    kierank Well-Known Member

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    Can capital gains be use to offset income tax losses?
     
  8. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    No. Only a CGT gain can reduce a CGT loss. However revenue losses can be applied to a capital gain as cap gains increase taxable income.
     
  9. kierank

    kierank Well-Known Member

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    We have run up some income tax losses in recent years, mainly due to depreciation. I knew these tax losses will be lost at death (hopefully, that is still many years in the future) and I am starting to think/plan about how to use them up.

    For self-funded pensioners like me, how does one use up income tax losses. I am starting to think it might be more difficult for us as our self-funded pension doesn't appear on our tax return, so there is not "more income" in the following FY.

    The two obvious strategies are:
    1. Go back to work and earn an income (not an attractive for me or the wife).
    2. Repay some IP debt to convert a negatively geared property portfolio into a positively geared portfolio (this is the one I am contemplating because we also want to reduce our risk as we age)
    Are there any other options?

    With the tax-free threshold being $36,400 for a couple (and with SAPTO, this increase to $57,948), it doesn't make sense to have tax losses hanging around any longer than necessary.

    We are due to meet with accountants in the next month or two to cover off a whole range of things including this item.

    At the moment, I am just doing research prior to the meeting so that I am better informed/educated for those discussions. My aim to have locked in any strategy at this meeting.

    All thoughts would be appreciated.
     
  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    One strategy is, if you have assets in a Discretionary Trust, to start selling - ideally before death, but even after. The trust could distribute to you and capital gains can then eat up the capital losses. Further shares may be bought to replace the ones sold - seek tax advice, especially on wash sales, as well as financial advice if shares.

    If you have cash in offset accounts this could potentially be shuffled around - move by lending children, or a discretionary trust etc.
     
  11. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    To use losses prior to death:

    1. CGT gains provided they are contracted prior to actual death. examples = sales, gifting investments to family etc. Remember CGT gain will use CGT losses FIRST then the net amount after discounts can offset income tax losses.
    2. Income eg invest in own name.
    3. Directed entitlements from a disc trust. eg kids. BUT beware of Centrelink etc.
    4. Assessable amounts eg termination amounts, some lump sums and foreign income (eg UK pensions)
    5. Sale of business on revenue and not CGT basis. eg Sale of depreciable assets for a intended profit instead of under small CGT business concessions
    6. Related party or investment sourced FF divs OR investments eg Draw $100K from super and invest this in CBA shares (take care of capital risks)

    Losses end on death. They cannot be utilised by a beneficiary or the executor.
    Entity losses may (or may not) be continued.

    The value of C/fwd losses may vary from 0% UP TO the taxpayers marginal tax rate (which could also be 00%).
     
    Last edited: 10th Feb, 2020
  12. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Plus Member

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    Keep in mind though, that were you have a property or shares with a capital loss that hasn't been realised it might be better not to realise it now, but to pass that asset on via the will so the beneficiary and realise the capital loss.
     
  13. Paul@PFI

    [email protected] Tax Accounting + SMSF Business Plus Member

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    The beneficiary general inherits assets (except the deceased's home) at the costbase of the deceased excepting pre-CGT assets. Many beneficiaries mistakenly believe they inherit assets at the value at the time of death and look at shares etc based on this value. The correct approach to avoid mischief to any beneficiaries is to determine the market value of assets and cash being distributed at the time of distribution and reduce this "value" by the accrued CGT position of the deceased at the time of their death so that the net position is distributed. This avoids one beneficiary inheriting a asset worth $100 and a tax liability of $25 v's their sibling who receives $100 cash.

    In many cases tax planning by beneficiaries and with co-operation of the executor may favour what each beneficiary is given as their share if it is not specified in the will (eg the common rest & residue clause) . eg Darths will may leave cash and shares to Luke & Leia. However if LIke has a c/fwd CGT loss he may prefer the shares vs cash. It doesnt mean the accrued CGT at death is ignored just because Luke pays none. Leila isnt disadvantaged but Luke can obtain a personal advantage. This issue is very common with an estate where beneficiaries may be non-resident. And will become more so with recent property CGT changes for non-residents. Non-residents may not be subject to CGT on shares.