Recapture of Prior-Year Overall Foreign Loss Accounts: Foreign Tax Credits (2025 IRS Guide)

This guide covers “Recapture of Prior-Year Overall Foreign Loss Accounts” within foreign tax credits. The following material presents the IRS treatment of this topic, including the qualifications, exceptions, and examples in the source section. Read the rules alongside the facts of your own situation before deciding what to report, deduct, or document.

Adapted from Publication 514 (2025), Foreign Tax Credit for Individuals, published by the Internal Revenue Service. This guide retains the source edition’s years, amounts, deadlines, and examples. It is guidance for that edition, not a statement that the same figures apply to every tax year.

Context for these rules

You must allocate foreign losses for any tax year and U.S. losses for any tax year (to the extent such losses do not exceed the separate limitation incomes for such year) among incomes on a proportionate basis.

Recapture of Prior-Year Overall Foreign Loss Accounts

If you have only losses in your separate limit categories, or if you have a loss remaining after allocating your foreign losses to other separate categories, you have an overall foreign loss. If you use this loss to offset U.S. source income (resulting in a reduction of your U.S. tax liability), you must recapture your loss in each succeeding year in which you have taxable income from foreign sources in the same separate limit category. You must recapture the overall loss regardless of whether you chose to claim the foreign tax credit for the loss year.

You recapture the loss by treating part of your taxable income from foreign sources in a later year as U.S. source income. In addition, if, in a later year, you sell or otherwise dispose of property used in your foreign trade or business, you may have to recognize gain and treat it as U.S. source income, even if the disposition would otherwise be nontaxable. See Dispositions, later. The amount you treat as U.S. source income reduces the foreign source income and therefore reduces the foreign tax credit limit.

You must establish separate accounts for each type of foreign loss that you sustain. The balances in these accounts are the overall foreign loss subject to recapture. Reduce these balances at the end of each tax year by the loss that you recaptured. You must attach a statement to your Form 1116 to report the balances (if any) in your overall foreign loss accounts.

Overall foreign loss.

You have an overall foreign loss if your gross income from foreign sources for a tax year is less than the sum of your expenses, losses, or other deductions that you allocated and apportioned to foreign income under the rules explained earlier under Determining Taxable Income From Sources Outside the United States. But see Losses not considered, later, for exceptions.

Example.

You are single and have gross dividend income of $75,000 from U.S. sources. You also have a greater-than-10% interest in a foreign partnership in which you materially participate. The partnership has a loss for the year, and your distributive share of the loss is $15,000. Your share of the partnership’s gross income is $220,000, and your share of its expenses is $235,000. Your only foreign source income is your share of partnership income, which is foreign branch category income. You are a bona fide resident of a foreign country and you elect to exclude your foreign earned income. You exclude the maximum $130,000. You also have itemized deductions of $34,000 that are not definitely related to any item of income.

In figuring your overall foreign loss for foreign branch category income for the year, you must allocate a ratable part of the $34,000 in itemized deductions to the foreign source income. You figure the ratable part of the $34,000 that is for foreign source income, based on gross income, as follows.

Therefore, your overall foreign loss for the year is $31,492 figured as follows.

Losses not considered.

You do not consider the following in figuring an overall foreign loss in a given year.

• Net operating loss deduction.

• Foreign expropriation loss not compensated by insurance or other reimbursement.

• Casualty or theft loss not compensated by insurance or other reimbursement.

Recapture provision.

If you have an overall foreign loss for any tax year and use the loss to offset U.S. source income, part of your foreign source taxable income (in the same separate limit category as the loss) for each succeeding year is treated as U.S. source taxable income. The part that is treated as U.S. source taxable income is the smaller of the following.

1. The total amount of maximum potential recapture in all overall foreign loss accounts. The maximum potential recapture in any account for a category is the lesser of:

   1. The current year taxable income from foreign sources in that category (the amount from Form 1116, line 15, less any adjustment for allocation of foreign losses and U.S. losses for that category, discussed earlier); or

   2. The balance in the overall foreign loss account for that category.

2. 50% (or more, if you choose) of your total taxable income from foreign sources.

If the total foreign income subject to recharacterization is the amount described in (1) above, then for each separate category the recapture amount is the maximum potential recapture amount for that category. If the total foreign income subject to recharacterization is the amount described in (2) above, then for each separate category the recapture amount is figured by multiplying the total recapture amount by the following fraction.

Example.

During 2024 and 2025, you were single and a 20% general partner in a partnership that derived its income from Country X. You also received dividend income from U.S. sources during those years.

For 2024, the partnership had a loss and your share was $20,000, consisting of $225,000 gross income less $245,000 expenses. Your net loss from the partnership was $8,756, after deducting the foreign earned income exclusion and definitely related allowable expenses. This loss is related to foreign branch category income. Your U.S. dividend income was $20,000. Your itemized deductions totaled $30,000 and were not definitely related to any item of income. In figuring your taxable income for 2024, you deducted your share of the partnership loss from Country X from your U.S. source income.

During 2025, the partnership had net income from Country X. Your share of the net income was $140,000, consisting of $200,000 gross income less $60,000 expenses. Your net income from the partnership was $49,000 after deducting the foreign earned income exclusion and the definitely related allowable expenses. This is foreign branch category income. You also received dividend income of $20,000 from U.S. sources. Your itemized deductions were $30,000, which are not definitely related to any item of income. You paid income taxes of $14,000 to Country X on your share of the partnership income.

When figuring your foreign tax credit for 2025, you must find the foreign source taxable income that you must treat as U.S. source income because of the foreign loss recapture provisions.

You figure the foreign taxable income that you must recharacterize as follows.

The amount of the recapture is shown on Form 1116, line 16.

Recapturing more overall foreign loss than required.

If you want to make an election or change a prior election to recapture a greater part of the balance of an overall foreign loss account than is required (as discussed earlier), you must attach a statement to your Form 1116. If you change a prior year’s election, you should file Form 1040-X.

The statement you attach to Form 1116 must show:

• The percentage and amount of your foreign taxable income that you are treating as U.S. source income, and

• The percentage and amount of the balance (both before and after the recapture) in the overall foreign loss account that you are recapturing.

Deduction for foreign taxes.

You must recapture part (or all, if applicable) of an overall foreign loss in tax years in which you deduct, rather than credit, your foreign taxes. You recapture the lesser of:

• The balance in the applicable overall foreign loss account, or

• The foreign source taxable income of the same separate limit category that resulted in the overall foreign loss minus the foreign taxes imposed on that income.

Dispositions.

If you dispose of appreciated trade or business property used predominantly outside the United States, and that property generates foreign source taxable income of the same separate limit category that resulted in an overall foreign loss, the disposition is subject to the recapture rules. In most cases, you are considered to recognize foreign source taxable income in the same separate limit category as the overall foreign loss to the extent of the lesser of:

• The FMV of the property that is more than your adjusted basis in the property, or

• The remaining amount of the overall foreign loss not recaptured in prior years or in the current year as described earlier under Recapture provision and Recapturing more overall foreign loss than required.

This rule applies to a disposition whether or not you actually recognized gain on the disposition and irrespective of the source (U.S. or foreign) of any gain recognized on the disposition.

In most cases, this rule also applies to a gain on the disposition of stock in a CFC if you owned more than 50% (by vote or value) of the stock right before you disposed of it. See Internal Revenue Code section 904(f)(3)(D) for more information.

All of the foreign source taxable income that you are considered to recognize under these rules is subject to recharacterization as U.S. source income in most cases. See Regulations section 1.904(f)-2(d).

If you actually recognized foreign source gain in the same separate limit category as the overall foreign loss on a disposition of property described earlier, you must reduce the foreign source taxable income in that separate limit category by the amount of gain you are required to recharacterize. If you recognized foreign source gain in a different separate limit category than the overall foreign loss on a disposition of property described earlier, you are required to reduce your foreign source taxable income in that separate limit category for gain that is considered foreign source taxable income in the overall foreign loss category and subject to recharacterization. If you did not otherwise recognize gain on a disposition of property described earlier, you must include in your U.S. source income the foreign source taxable income you are required to recognize and recharacterize.

Predominant use outside United States.

Property is used predominantly outside the United States if it was located outside the United States more than 50% of the time during the 3-year period ending on the date of disposition. If you used the property fewer than 3 years, count the use during the period it was used in a trade or business.

Disposition defined.

A disposition includes the following transactions.

• A sale, exchange, distribution, or gift of property.

• A transfer upon the foreclosure of a security interest (but not a mere transfer of title to a creditor or debtor upon creation or termination of a security interest).

• An involuntary conversion.

• A contribution to a partnership, trust, or corporation.

• A transfer at death.

• Any other transfer of property whether or not gain or loss is normally recognized on the transfer.

The character of the income (for example, as ordinary income or capital gain) recognized solely because of the disposition rules is the same as if you had sold or exchanged the property.

However, a disposition does not include either of the following.

• A disposition of property that is not a material factor in producing income. (This exception does not apply to the disposition of stock in a CFC to which Internal Revenue Code section 904(f)(3)(D) applies.)

• A transaction in which gross income is not realized.

Basis adjustment.

If gain is recognized on a disposition solely because of an overall foreign loss account balance at the time of the disposition, the recipient of the property must increase its basis by the amount of gain deemed recognized. If the property was transferred by gift, its basis in the hands of the donor immediately prior to the gift is increased by the amount of gain deemed recognized.

Using the guidance

Keep the documents that establish the dates, amounts, and circumstances described above. References to other chapters, forms, worksheets, or earlier and later sections refer to the linked IRS publication. Check the full publication and its updates before relying on a rule for a different tax year or a situation not addressed here.

Sources and further reading

• Publication 514 (2025), Foreign Tax Credit for Individuals: How To Figure the Credit — Allocation of Foreign and U.S. Losses — Recapture of Prior-Year Overall Foreign Loss Accounts — Internal Revenue Service; 2025 edition.

The cited U.S. government text is in the public domain. Source accessed October 28, 2026. Fynoptic has organized this material for educational use and is independent of, and not endorsed by, the IRS.