Editors' pick: Originally published Oct. 14.

Offsetting losses against income for 20 years to avoid paying taxes is a lot like marrying your first cousin in Colorado. It's actually legal. It just feels really wrong. 

Donald Trump reported a $916 million loss in 1995, according to state tax returns obtained by the New York Times. And because of quirky tax rules that let him "carry that forward," he may not have to pay any taxes for many, many years to come. 

Is it legal? Probably.

Is it aggressive? Probably.

Does it feel morally wrong? Definitely.

But morals are irrelevant here. It's all about saving money.

No one is going to fault him or anyone for using the tax code to his benefit. And therein lies the overreaching problem. People like Trump can hire the smartest minds in the world to use every tax loophole available to save them money.

So the little guy - and the IRS's workforce -- don't stand a chance.

But let's back up. We first need to understand loss carryforward provisions and pass-through entities. 

Only then we can speculate about Trump's big fat loss.

So pour a stiff cup of coffee.

What is a Carryforward Loss?

There are actually three basic loss carryforward types allowed in the tax code, says Fred Slater, CPA and partner at MS1040 LLC in Manhattan. 

So in VERY simple terms:

  1. Capital Loss. A capital loss is generated when you sell any investment, like a stock or share of a mutual fund, for less than you bought it. But you can only deduct a maximum loss of $3,000 each year. So if your total net capital losses are $10,000, the remaining $7,000 can be carried forward and offset again any gains until you die.
  1. Net Operating Losses (NOLs). A business that has more expenses than revenues has a net operating loss. You can offset that loss against any other income you have. The remaining loss can be carried forward and used to offset any income for the next 20 years. After 20 years, whatever loss is unused, is lost.

NOLs are totally normal. Businesses can have losses for many years. Amazon was in business for almost 20 years and still reported NOLs.

  1. Passive Losses. Any loss you generate from an investment in any business where you are not a material participant is a passive loss. So that can include investments in rental properties or business partnerships, like Donald Trump did. Again, losses can be offset against gains, and any leftover can be carried forward indefinitely.

(Check out Form 8582 - Passive Activity Loss Limitations in case you need something to put you to sleep tonight.) 

What is a Pass-Through Entity?

Structuring your business as a pass-through entity can actually be a smart move. 

Sole proprietorships, partnerships, LLCs and S corporations all are pass-through entities for federal tax purposes. That means the entities don't pay tax. Instead the income -- or losses -- flow through to the individuals' tax returns, and they owe the tax bill. 

Hedge funds and small businesses are often set up this way, notes Elda Di Re, a tax services partner at Ernst & Young, who services high net worth individuals. 

And it works to keep the tax bill down, especially in the beginning. If the business has losses, they can be used to offset any other income on the individual's tax return. 

On the flipside, if you set your new business up as a C corporation, which most big companies are, then it is subject to the higher corporate tax rates. Dividends can be distributed to you - but only after the corporation pays tax on them. You then will have to report those dividends as income on your individual tax return and owe taxes again

That is exactly how Warren Buffet's Berkshire Hathaway is structured. 

Berkshire Hathaway is a C corporation. That means nothing but dividends that are distributed to Warren Buffet will show up on his tax return. So Buffett will never have pass-through losses from his businesses onto his personal tax return, as Trump suggested.

Any carryforward losses that Berkshire may or may not have will remain on its corporate tax return.

But because of this dividend double taxation issue, many business owners try to avoid structuring as a C corporation.

For that reason, "the vast majority of businesses are pass-through entities," says Di Re.

Enter the Super Speculation

Of course, there's a parade of pundits trying to surmise where Trump generated that $916 million loss.

To start, Trump set up his investments as a pass-through entity, which is smart and standard, especially when you invest in real estate. (Calling him a "genius," may be a stretch though.)

Real estate is depreciated, which means each year it is worth less for tax purposes. And you can deduct a piece of that real estate each year in the form of a depreciation deduction. If the property did not make any money, that deduction becomes a loss. 

So all those losses flow through to his personal tax return, which can be used to offset Trump's other income.

Great. But here's the rub.

The New York Times obtained copies of the front pages of his 1995 Connecticut, New York and New Jersey returns. And they showed a $916 million loss, which comes from his federal Form 1040. 

So how do you generate a loss that big? It can't all be from depreciation. Many are speculating: it could be losses from the three Atlantic City casinos he messed up or maybe even some of his botched projects in Manhattan. 

And they're probably not wrong. 

But again, we don't know.

The problem is this stuff flows through from somewhere else. Trump is invested in more than 100 LLCs and other passive entities, notes Slater. And we don't have any of that back-up detail. 

Even worse, that loss could actually be bigger now, notes Di Re. 

He could just release his tax returns and put an end to all this, but if he truly is in the midst of an audit, then adding a bunch of pundits to the audit team is not going to help him.

The tax code is not easy to decipher, and so many things are subject to interpretation. 

But other things are not.

So the next time you look at your cousin, just turn away.