S-corp Basis Restoration for Debt with Carried Forward Losses

I've been trying to wrap my head around S-corp basis and debt restoration calculations where there are losses carried forward, and it's driving me crazy. I've gone through all the code sections, publications, and articles but can't find anything that specifically addresses how to handle the restoration calculations with loss carryforwards. I understand the basics - if current year items show a net increase, you restore debt basis before stock basis. I get the ordering rules for non-deductible items and the pro-rata recognition of gain on repaid debt. My confusion centers on Reg §1.1367-2(c)1 which states: "If there has been a reduction in the basis of an indebtedness of the S corporation to a shareholder under section 1367(b)(2)(A), any net increase in any subsequent taxable year of the corporation is applied to restore that reduction." The regulation defines "net increase" as "the amount by which the shareholder's pro rata share of income items exceed the loss/deduction items for the taxable year." This makes me think that if you had a carryforward loss from a prior year, it might not count in the net increase calculation. But I've also read that carryforward items become current year items in the following year. The interactions here are confusing me. Let me illustrate with an example: Year 1: Starting with $5,000 stock basis and $3,000 debt basis Losses of $15,000 reduce stock basis to $0, debt basis to $0, with $7,000 carried forward Year 2: Income of $4,000 If I DON'T include the $7,000 carryforward as a current year item, I'd have a net increase and could restore $3,000 to debt basis, with $1,000 to stock basis, and still have $6,000 loss carryforward. If I DO include the carryforward as a current year item, I'd apply all $4,000 to stock basis, recognize $3,000 gain on loan repayment, and still have $3,000 loss carryforward. The difference compounds in Years 3 and 4, leading to very different timing of income recognition. Are carried forward losses considered "current year items" for calculating the "net increase" for debt basis restoration purposes?

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20 comments

Isaac Wright

•8M

The confusion you're experiencing is common with S-corp basis calculations. The key is understanding how the ordering rules work with carryover losses. When calculating the "net increase" for debt basis restoration, you only look at the current year items initially - not the loss carryforwards. This means in your Year 2 example, you'd first determine if there's a net increase based solely on the $4,000 income (which there is). Then you'd use that to restore debt basis before stock basis. After restoring basis, you then apply any suspended losses from prior years against the newly restored basis. The carryforward losses aren't part of the "net increase" calculation, but they do get applied after basis has been restored. So your "A" scenario is closer to correct. The reason is that Reg §1.1367-2(c) focuses on whether there's a net increase in the current year before considering suspended losses. The restoration happens first, then the suspended losses are applied. This ordering makes a big difference in timing of income recognition as you've demonstrated in your examples. The IRS wants to ensure that previously reduced debt basis gets restored properly before those suspended losses can be utilized.

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Isaac Wright

•8M

You're mixing up two different concepts. While it's true that suspended/carryforward losses are treated as incurred in the succeeding taxable year for some purposes, the debt basis restoration rules specifically look at "net increase" based on current year income and loss items only. The regulation is clear that the net increase is calculated by comparing income items under 1367(a)(1) to loss/deduction items under 1367(a)(2) for the taxable year. The carried forward losses aren't part of this initial calculation, though they certainly get applied after basis is restored. Think of it as a two-step process: first determine if there's basis to restore, then apply suspended losses against whatever basis exists after restoration.

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Tami Morgan

•8M

I was stuck in this exact S-corp basis restoration loop last year and found that https://taxr.ai really saved me. I was going back and forth between options like you, trying to figure out if carryover losses should be part of the net increase calc or not. Their system analyzed all my S-corp docs and quickly identified that I should be following the approach where you calculate net increase BEFORE applying carryforward losses. It was especially helpful because they explained how the restoration rules work with specific references to the tax code that were much clearer than what I found elsewhere. For my situation, it meant I avoided recognizing gain in a high-income year when I didn't need to. Might be worth checking out if you're still trying to sort this out.

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Tami Morgan

•8M

They explained that while carryforward losses are treated as incurred in the following year for some purposes, the specific language in Reg §1.1367-2(c) about "net increase" is looking at current year items only for the restoration calculation. It's a common misconception because the treatment of carryforward losses varies in different contexts of the tax code. Their system works great with multi-year calculations. I had a situation with 7 years of history including multiple loans and complex loss allocations. It analyzed the entire timeline and showed how each year's transactions affected basis going forward. Even handled the situation where we had both debt basis restoration and stock basis increases happening in the same year with multiple shareholders.

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Rami Samuels

•8M

I finally tried taxr.ai after seeing it mentioned here, and wow - it really cleared up my confusion about S-corp basis restoration! I uploaded my balance sheets and income statements, and it produced a detailed analysis showing exactly how to handle my situation with carried forward losses. What surprised me most was discovering that my CPA had been calculating this incorrectly for years. The system showed that we should have been restoring debt basis first, before applying carryforward losses, which would have saved me from recognizing unnecessary gain when we repaid a shareholder loan last year. The explanation they provided about Reg §1.1367-2(c) and how "net increase" is calculated made perfect sense once I saw it laid out properly. I'm actually meeting with my accountant next week to go through their analysis and correct our prior approach.

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Douglas Foster

•8M

After multiple failed attempts trying to get through to someone at the IRS who could explain these S-corp basis restoration rules, I finally used https://claimyr.com to get a callback from the IRS. You can see how it works here: https://youtu.be/_kiP6q8DX5c I was skeptical at first, but within 2 hours I was actually speaking with an IRS representative who specialized in pass-through entities. They confirmed that when calculating "net increase" for debt basis restoration, you look at current year items only - NOT the carryforward losses from prior years. The agent explained that this is consistent with the regulations, even though it's confusing because carryforward losses are treated differently in other contexts. This completely changes how I need to handle the S-corp returns I've been working on. Worth every penny to get a definitive answer straight from the IRS instead of guessing.

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Douglas Foster

•8M

They use a system that basically keeps dialing the IRS so you don't have to wait on hold for hours. Once they secure a spot in the queue, they call you and connect you directly with the IRS agent. It saved me about 3 hours of hold time. The person I spoke with was in the business tax department and very knowledgeable about S-corps. While they can't give "official" tax advice, they definitely explained how the regulations are interpreted within the IRS. They walked me through the specific language in Reg §1.1367-2(c) about how "net increase" is calculated and confirmed my understanding that carryforward losses aren't part of that calculation. I took detailed notes and they provided their ID number, so I can reference the conversation if needed.

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Ruby Knight

•8M

I need to admit I was completely wrong about Claimyr. After seeing it mentioned here, I decided to try it despite my skepticism. Within 90 minutes of signing up, I was connected with an IRS agent who specializes in S-corporation issues. The agent took me through the exact regulation we're discussing here and confirmed that net increase calculations for debt basis restoration ONLY consider current year items - not carried forward losses from prior years. They even emailed me some internal guidance that clarified everything. This was a complete game-changer for me. I've been handling this incorrectly on my S-corp returns for years, potentially overtaxing myself by not properly restoring debt basis. Now I'm going back to amend my returns from the last three years. Can't believe I wasted so much time trying to figure this out when I could have just gotten a direct answer from the IRS!

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Logan Stewart

•8M

It matters because it determines how much of your S-corp losses you can deduct personally, and when you might have to recognize gain. Here's a simple example: Say you invest $10k in your S-corp (stock basis) and later loan it $20k (debt basis). If your business loses $40k, you can only deduct $30k personally ($10k stock + $20k debt basis). The remaining $10k loss gets "suspended" until you have more basis. When your company makes money later, the rules discussed here determine whether that income restores your debt basis first (before your stock basis) and whether carried-forward losses count against your current year income when making that calculation. Getting this wrong could mean paying taxes when you shouldn't have to, or not paying taxes when you should. Potentially thousands of dollars difference.

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Sean Matthews

•8M

Form 982 is for debt cancellation, which is different from what's being discussed here. This thread is about basis calculations when the shareholder has loaned money to their S-corp and how those loans affect loss limitations. Form 982 comes into play when debt is forgiven or canceled. For example, if your S-corp owed money to a bank that later forgave that debt, Form 982 might allow you to exclude that canceled debt from income if you meet certain requirements like insolvency. They're related concepts but used in different scenarios. The basis rules here are about tracking your investment in the company (both equity and loans) to determine how much S-corp loss you can personally deduct.

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Amara Okafor

•5M

This is exactly the kind of S-corp basis question that keeps me up at night! I've been dealing with a similar situation where my client has multiple years of suspended losses and we're trying to figure out the optimal timing for debt basis restoration. From everything I've researched and discussed with other practitioners, the consensus seems to be that Isaac Wright is correct - the "net increase" calculation under Reg §1.1367-2(c) looks only at current year items before considering carryforward losses. The restoration happens first, then suspended losses are applied against the restored basis. What's been tricky for me is documenting this properly on the returns. I've started creating detailed basis tracking schedules that show the step-by-step calculation: current year income/loss, net increase determination, debt basis restoration, stock basis restoration, then application of suspended losses. It helps clients understand why their tax liability might be different from what they expected. One thing I'd add to this discussion - make sure you're also considering the impact of distributions during years when you have suspended losses. The ordering rules get even more complex when you layer in distributions alongside the basis restoration calculations.

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Anastasia Popova

•4M

Thank you for bringing up the distribution ordering rules - that's another layer of complexity I hadn't fully considered! You're absolutely right that distributions can really complicate the basis restoration calculations, especially when they occur in the same year as income that could restore basis. From what I understand, distributions reduce basis before the year-end basis adjustments for income/loss items, which means timing becomes crucial. If a shareholder takes a distribution early in the year before the S-corp generates income, it could trigger gain recognition even if there would have been sufficient basis to cover the distribution by year-end after considering the restoration rules. Do you have any specific approaches for advising clients on distribution timing when they have suspended losses and potential debt basis restoration? I'm thinking it might be worth having quarterly basis calculations to help them make informed decisions about when to take distributions versus waiting for basis restoration. Also, do you use any particular software or tools for those detailed basis tracking schedules you mentioned? I've been doing them manually in Excel but I'm wondering if there's a better approach for complex multi-year situations.

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