How to Write a Net Operating Loss (NOL) Explanation Statement for Rental Property

Thanks for this advice. I'm in a similar situation but confused about the active participation part. I hired a property management company for my rental - does that disqualify me from claiming the NOL since I'm not "active" in managing it? My CPA said something about PAL rules but I'm not sure how that affects the NOL calculation.

Having a property management company doesn't automatically disqualify you from claiming active participation. The "active participation" standard is actually quite low compared to "material participation." As long as you make management decisions like approving tenants, setting rental terms, or approving capital improvements, you can still qualify as actively participating despite using a management company. Regarding PAL (Passive Activity Loss) rules, they're separate from NOL rules but related. Typically, rental losses can only offset passive income due to PAL limitations. However, there's a special allowance that lets you deduct up to $25,000 of rental losses against non-passive income if your modified AGI is below certain thresholds and you actively participate. If your losses weren't limited by PAL rules but you still had an overall loss for the year, that's when NOL rules come into play.

Did it handle the passive activity loss rules too? I'm never sure how those interact with NOLs when you have rental properties. Also, did you need to provide any special documents or just your tax returns?

I'm skeptical about these tax tools. Did it actually give you language for the explanation statement that you could just copy/paste? My accountant charges me $350 just to handle NOL situations so if this works it would save me a bunch.

Yes, it handled the passive activity loss rules as part of the analysis. It asked me questions about my level of involvement in the rental property management to determine if I qualified for the active participation exception. It actually pointed out that I needed to complete Form 8582 first to calculate how much of my rental loss was allowed before determining the NOL amount. For documents, I just uploaded my previous year's complete tax return PDF and my draft current year return. The system extracted all the necessary information from those. It was much easier than I expected. The explanation statement was completely customized to my situation with all the correct numbers and citations to the tax code. It was formatted exactly how the IRS expects to see it, and I could either copy/paste the text or download it as a PDF to attach to my return. Definitely saved me from paying my accountant for something that turned out to be pretty straightforward once it was explained properly.

How does this actually work? Do they just call the IRS for you? Seems like something I could do myself.

This sounds fake. Nobody gets through to the IRS in 15 minutes. I've been trying for weeks to get answers about my NOL calculation and can't even get past the automated system. If this really works I'll be shocked.

They don't just call for you - they use a system that navigates the IRS phone tree and waits on hold for you. When they reach a live agent, you get an immediate callback to connect with that agent. So while technically you could do it yourself, you'd be the one waiting on hold for hours instead of doing other things. The technology basically keeps your place in line without you having to listen to hold music for hours. It's similar to those restaurant apps that text you when your table is ready, except for IRS phone queues. I was skeptical too when I first heard about it. I'd spent over 8 hours across multiple days trying to get through. The longest I'd waited before giving up was 3.5 hours. With Claimyr, I got a call back in about 12 minutes saying they had an agent on the line. It was genuinely surprising how well it worked.

Does the statement need to be in a specific format? I've been just including a note in my tax software's additional information section. Is that enough or do I need a separate attachment?

The statement should be on a separate sheet of paper with your name and social security number at the top, labeled "Statement - Net Operating Loss Carryover." Most tax software has a function to create and attach statements, but simply putting it in the notes section isn't sufficient. The IRS specifically looks for these attachments when processing returns with NOL claims. The attachment should be referenced on the specific line where you're claiming the NOL (Schedule 1, line 8a) with something like "See attached statement." This ensures the processing center connects your explanation to the actual deduction.

This is exactly what confused me! So first I need to determine how much rental loss I can use against other income using Form 8582, and only THEN figure out if I have an NOL? I thought I could just carry forward the full rental loss as an NOL.

@Dylan Mitchell Exactly right! The passive activity loss rules PAL (are) applied first, then NOL rules come into play. Here s'the sequence: 1. Calculate your rental property loss on Schedule E 2. Apply PAL limitations using Form 8582 to determine how much rental loss you can deduct against non-passive income up (to $25,000 if you actively participate and meet AGI limits 3.) Any rental losses not allowed due to PAL rules are suspended for future years 4. Use the allowed rental loss from (step 2 in) your overall tax calculation 5. If your total deductions still exceed your total income after applying PAL rules, then you have an NOL You can t'carry forward the full rental loss as an NOL if it was limited by PAL rules. Only the portion that was actually allowed in the NOL year can contribute to the NOL calculation. This is a common misconception that trips up a lot of people with rental properties. Make sure your NOL explanation statement clearly shows you went through this process - the IRS will definitely check both calculations.

This is really helpful! I'm new to dealing with NOLs and was getting overwhelmed by all the different rules. Your revised explanation statement template makes it much clearer how to structure this properly. One question - when you mention calculating the NOL based on the "total adjusted situation," do you mean I should show the full math in my explanation statement? Like actually listing out all my income sources and deduction categories that led to the overall loss? Or is it enough to just reference the key figures like you did in your example? Also, I noticed you mentioned the unused portion being $21,700 but only carrying forward $3,200 - I'm a bit confused about that part. Shouldn't the NOL be the full amount that deductions exceeded income?

@Abigail Spencer Good catch on those numbers! I should clarify that calculation. You re'absolutely right that the NOL would typically be the full amount that deductions exceeded income $21,700 (in this example .)However, in the original post, Yuki mentioned only carrying forward the $3,200 rental loss portion as an NOL. This suggests they may be treating only the rental loss as the NOL carryforward rather than the full excess deduction amount. This is actually a common approach when you have specific business or rental losses that you want to track separately, even though technically the entire excess could qualify as NOL. For the explanation statement detail level, you don t'need to show every single income source and deduction line-by-line. The IRS mainly wants to see: 1. The key figures that created the NOL income (vs. deductions totals 2.) How you calculated the specific amount you re'carrying forward 3. Clear references to the tax forms and publications you used 4. Confirmation that you properly applied any limitation rules first like (PAL rules Your) explanation should be thorough enough that an IRS reviewer can understand and verify your calculation without being overly detailed. The revised template I suggested hits that balance, but you can certainly add more detail if your situation is particularly complex.

This is exactly the kind of detailed guidance I was looking for! I'm dealing with my first NOL situation and was worried about getting the documentation wrong. The point about explaining the calculation discrepancy is particularly important - I was wondering why someone would only carry forward part of their total excess deductions. Is this a strategy to preserve some NOL for future years when it might be more beneficial? Or is there a specific tax reason to limit it to just the rental loss portion? Also, when you mention "processing delays or correspondence from the IRS," what typically happens if the explanation statement is incomplete? Do they just send a letter asking for clarification, or could it trigger a more serious review of the return? Thanks for breaking this down so clearly - it's really helpful to see the specific formatting and language requirements laid out step by step.

@Zara Ahmed Great questions! There are actually strategic reasons why someone might choose to carry forward only the rental loss portion rather than the full NOL amount. First, rental losses have special tracking requirements due to passive activity rules. By limiting the NOL carryforward to just the rental loss, you maintain clearer documentation of how that specific loss is being utilized across tax years. This becomes important if you have multiple rental properties or other passive activities in future years. Second, you might want to preserve the non-rental portion of the excess deductions like (the itemized deductions that exceeded income for) potential future use under different NOL rules or if your tax situation changes significantly. Regarding IRS processing issues, incomplete NOL documentation typically results in: 1. **Initial processing delays** - Your return gets flagged for manual review instead of automated processing 2. **CP2000 notices** - The IRS sends a proposed "changes letter" questioning the NOL deduction 3. **Request for additional information** - They ll'ask for the missing documentation before accepting the NOL claim 4. **Potential audit selection** - Incomplete NOL claims are red flags that can increase audit risk The good news is that if you respond promptly with proper documentation, these issues usually resolve without penalties. However, it can delay any refund you re'expecting and create months of back-and-forth correspondence. That s'why getting the explanation statement right upfront is so important - it prevents these headaches entirely.

This is really comprehensive advice! As someone new to this community and dealing with my first NOL situation, I really appreciate how clearly you've laid out all the requirements. I'm in a similar position with a rental property loss from 2022 that I want to carry forward to 2023. Your point about explaining why you're only carrying forward the rental portion instead of the full excess deductions is something I hadn't considered - that makes total sense for maintaining clear records. One quick question: when you mention referencing the attachment on Schedule 1, line 8a, should that reference be in addition to entering the actual dollar amount, or does the reference replace entering the amount directly on the form? I want to make sure I'm not double-reporting or missing something obvious. Thanks for taking the time to break this down so thoroughly. It's exactly the kind of detailed guidance that helps newcomers navigate these complex tax situations properly.