Offsetting Losses for Tax Purposes

When Can a Loss Become a Tax Asset?

The basic framework under Israeli law does not treat all losses in the same way. Not every loss is recognized for the same purpose, and not every loss can be offset in the same manner. There is a difference between a business loss, a capital loss, and a loss from securities, and each is subject to different rules. The year in which the loss was created, the way it was reported, and the type of income against which the offset is sought are also important. Therefore, in order to understand whether a particular loss can actually reduce tax liability, it is necessary to examine not only its amount, but also its classification and the conditions that apply to it.

Section 28 of the Income Tax Ordinance mainly deals with the offset of revenue losses generated in Israel, primarily losses from a business or vocation. In parallel, Section 92 of the Ordinance deals with the offset of capital losses, including losses arising from the realization of assets and, in certain cases, from securities. Each type of loss is subject to a different track, different limitations, and sometimes also different tax planning opportunities.

Business Loss

With respect to a business loss, one of the most important distinctions is between a current loss and a carried-forward loss. When a loss from a business or vocation is generated during the tax year, the law allows, subject to the conditions set out in the Ordinance, relatively broad flexibility in offsetting it against other income. By contrast, when the loss is not fully utilized and is carried forward to subsequent years, the ability to offset it is generally narrowed to income connected to the business or vocation, and to certain additional cases prescribed by law. The difference between utilizing a loss in the year in which it is generated and carrying it forward to future years can be highly significant. For that reason, advance consideration is sometimes required regarding the timing of income, realizations, and other actions that may affect the outcome.

Section 28 of the Income Tax Ordinance is particularly important for business owners, professionals, and individuals who operated as self-employed persons. It reflects the view that there is a difference between a year in which the business is still active and presents a dynamic picture of profit and loss, and a situation in which the loss is already being “carried” forward to later years. In certain cases, an individual who ceased business activity and became an employee may also examine the possibility of offsetting a carried-forward loss against employment income. However, this is not an automatic route and depends on specific conditions set by law. Therefore, a transition from self-employment to employment, the closure of an activity, a change in the structure of income, or the opening of an alternative activity are not merely employment or business events. They are also points at which the loss position should be reassessed.

Loss from Securities

In the investment world as well, offsetting losses for tax purposes is far from a mechanical exercise. Losses from securities are generally incorporated into the rules governing capital losses, but they have characteristics that justify separate attention. When the bank performs an offset during the tax year, it is important to check whether there were additional capital gains that were not reviewed together with the securities portfolio, whether dividends or interest were received against which the loss could have been considered, and whether there are carried-forward losses from previous years whose full impact has not been examined. In other words, the technical mechanism applied by the financial institution is not always a substitute for a comprehensive tax analysis.

In this context, it is important to distinguish between a current loss from securities and a carried-forward loss. While in the year in which the loss is generated, certain offset options may be available also against dividend or interest income from securities, subject to the conditions set by law, once the loss is carried forward to subsequent years, the offset track may become narrower. This is one of the reasons why reviewing the outcome only at the end of the process may be too late. Sometimes, the difference between an action taken in December and a similar action postponed to January is not economically material. However, from the perspective of utilizing the loss for tax purposes, it may change the result.

What Does the Israel Tax Authority Review?

The Israel Tax Authority, for its part, does not settle for the mere existence of an accounting or economic loss. In practice, the review focuses on several layers. First, the type of loss and its source are examined: whether it is a business loss, a capital loss, a loss from securities, or a loss originating outside Israel. Second, the question is whether, had a gain been generated instead of a loss, that gain would have been taxable in Israel. Third, the timing and reporting are examined: whether a return was filed for the year of the loss, whether the loss was classified consistently, and whether there is supporting documentation for the position taken. Finally, in many cases, the connection between the loss and the source of income against which the offset is sought is also considered. This point arises repeatedly, especially when taxpayers assume that all types of income are merged into a single “basket,” while the Ordinance operates through distinctions, tracks, and conditions.

In our professional experience, one of the common mistakes in this area does not necessarily stem from aggressive tax planning, but rather from the mistaken assumption that the loss will “take care of itself.” Sometimes, a business owner carries a loss from previous years in the reports, but does not examine whether the conditions that will allow it to be offset in the future have been preserved. Sometimes, an investor assumes that the treatment carried out through the bank exhausts the available options, even though a broader picture could have been examined in the annual tax return. In other cases, the loss exists economically, but no return was filed for the year in which it was generated, or sufficient documentation was not retained. The result is that not every loss felt in one’s pocket necessarily receives effective recognition under tax law.

Assume, for example, that an individual operated a business activity and, in the same year, incurred a loss of ₪180,000.

At the same time, a private investment portfolio generated a capital gain of ₪90,000, and later that year, a dividend distribution from a family company in which the individual holds shares was also considered. Intuitively, that individual might think that all losses and gains will automatically meet in the tax return without any active action or review on their part. In practice, a precise analysis is required of the type of loss, the type of gain, the relevant statutory track, and the question of timing. If the actions are not examined in advance, a situation may arise in which part of the loss is utilized less efficiently, or is carried forward to subsequent years under more restrictive rules, causing the individual to lose a significant amount of money.

In summary, offsetting losses for tax purposes is an area that sits between the strict provisions of the law and practical decision-making. It requires an accurate reading of the provisions of the Ordinance, particularly Section 28 and Section 92, but also an understanding of the broader business and financial context. A loss can reduce tax liability, improve cash flow, and change the way a particular tax year should be planned. However, for that to happen, proper classification, correct reporting, organized documentation, and a review of timing are required. That is precisely where the real value of professional advice lies.

Nimrod Yaron & Co. Firm specializes in Israeli and international taxation. Our team is composed of professionals with years of experience at the Israel Tax Authority, alongside experience at leading firms and law offices, bringing together both legal and economic perspectives. We advise private and public companies, Israeli and foreign companies, global venture capital funds, and clients seeking focused advice in clear, accessible language. We also work with a professional network of accounting firms and law firms around the world, in order to provide comprehensive support in cross-border matters.

If you have incurred business losses, capital losses, or losses from securities, it is advisable to review the overall picture before filing the return or before taking an additional step. An early review can help clarify which options are available, which documents are required, and where more careful planning is needed.

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