What this line means
The portion of your net operating loss (NOL) that is reduced because you excluded canceled debt from income. NOLs are reduced dollar-for-dollar — every $1 of excluded debt reduces your NOL by $1. This is the first tax attribute reduced under the standard ordering rules of Section 108(b)(2), which means your NOLs are consumed before credits, capital losses, or property basis.
Does this apply to you?
- You excluded canceled debt from income on line 2 and have a net operating loss for the tax year of the discharge
- You have an NOL carryover from a prior year that has not yet been used
- You did not check box 1e only (the principal residence exclusion uses a different reduction method unless you opt into standard ordering)
- Your excluded debt amount has not been fully absorbed by the principal residence basis reduction on line 3
Easy to overlook
The NOL reduction includes both current-year and carryover NOLs Line 4 reduces your NOL for the tax year of the discharge first, then any NOL carryovers from prior years. Filers with large carryover NOLs from previous business losses may see years of accumulated losses wiped out by a single debt cancellation. Check whether the insolvency or bankruptcy exclusion amount is worth the NOL reduction. 1 IRS Form 982 Instructions — Line 4
You can elect to reduce basis before NOLs under Section 108(b)(5) If you want to preserve your NOLs, you can elect on line 10b to reduce the basis of depreciable property first. This skips the standard ordering rules and goes straight to depreciable property basis. If your depreciable assets have enough basis to absorb the excluded amount, your NOLs survive intact. 2 IRS Publication 4681 — Canceled Debts, Foreclosures, Repossessions, and Abandonments
Watch out for this
Failing to reduce the NOL on the return for the discharge year. The attribute reduction happens at the beginning of the tax year following the discharge (or, for the NOL of the discharge year, at the end of the discharge year). If you carry forward an unreduced NOL to the next year, the IRS will adjust it and you will owe additional tax plus interest on the overstatement.
Footnotes
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IRS Form 982 Instructions, Line 4. https://www.irs.gov/instructions/i982 ↩
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IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, Chapter 1. https://www.irs.gov/pub/irs-pdf/p4681.pdf ↩