Business Tax Preparation · Business expenses, deductions and credits

Net operating loss deduction

The loss limitations topic sets out where a net operating loss sits among the four limitations. This page is about the loss itself: what the statute counts, what it strips out, and how the carryover rules have moved three times since 2017.

The rule

Definition. the excess of the deductions allowed by chapter 1 over gross income, computed with the modifications in IRC § 172(d)^TY2026Verified 2026-08-21IRC § 172(c), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(c)). Note that it starts from deductions over gross income, not from anything on a set of accounts.

The modifications. no net operating loss deduction is allowed in computing the loss itself, so a carryover from an earlier year cannot enlarge the current year's loss^TY2026Verified 2026-08-21IRC § 172(d)(1), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(1)); for a taxpayer other than a corporation, capital losses are deductible only to the extent of capital gains, and the IRC § 1202 exclusion is disallowed^TY2026Verified 2026-08-21IRC § 172(d)(2), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(2)); no deduction for personal exemptions (IRC § 172(d)(3)); and, most importantly, for a taxpayer other than a corporation, deductions not attributable to a trade or business are allowed only to the extent of gross income not derived from that trade or business^TY2026Verified 2026-08-21IRC § 172(d)(4), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(4)).

What counts as business, for that test. gain or loss on depreciable property or real property used in the trade or business is treated as attributable to it, as is a casualty or theft loss allowable under IRC § 165(c)(2) or (3) — but a IRC § 404 deduction for contributions on behalf of a self-employed individual is not^TY2026Verified 2026-08-21IRC § 172(d)(4)(A), (C) and (D), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(4)(A), (C), (D)).

Where it goes. a net operating loss arising in a taxable year beginning after 31 December 2017 is carried forward to each taxable year following the year of the loss, without limit; one arising before that date was carried to each of the 20 following years^TY2026Verified 2026-08-21IRC § 172(b)(1)(A)(ii), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(A)(ii)), used within 80 percent — for a taxable year beginning after 31 December 2020 the deduction for losses arising after 2017 is capped at 80 percent of taxable income computed without the IRC § 172, § 199A and § 250 deductions; losses arising before 2018 are deducted first and are not capped^TY2026Verified 2026-08-21IRC § 172(a)(2), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(a)(2)). The exceptions are a farming loss is carried back to each of the 2 taxable years preceding the year of the loss^TY2026Verified 2026-08-21IRC § 172(b)(1)(B)(i), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(B)(i)) and an insurance company other than a life insurance company keeps the older regime — a 2-year carryback and a 20-year carryforward^TY2026Verified 2026-08-21IRC § 172(b)(1)(C), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(C)).

Waiving a carryback. a taxpayer entitled to a carryback may elect to relinquish the entire carryback period, by the due date including extensions for the year of the loss, and the election is irrevocable for that year^TY2026Verified 2026-08-21IRC § 172(b)(3), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(3)).

Current figures

How it works in practice

A net operating loss is smaller than the loss the taxpayer thinks they have. For a corporation, the definition and the accounting loss are usually close. For an individual they are not, because for a taxpayer other than a corporation, deductions not attributable to a trade or business are allowed only to the extent of gross income not derived from that trade or business^TY2026Verified 2026-08-21IRC § 172(d)(4), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(4)) allows non-business deductions only against non-business income. Itemized deductions, the standard deduction, and personal deductions of every kind are pared back to the amount of investment income and other non-business gross income, and anything above that simply does not enter the loss.

The statute then hands three categories back. gain or loss on depreciable property or real property used in the trade or business is treated as attributable to it, as is a casualty or theft loss allowable under IRC § 165(c)(2) or (3) — but a IRC § 404 deduction for contributions on behalf of a self-employed individual is not^TY2026Verified 2026-08-21IRC § 172(d)(4)(A), (C) and (D), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(4)(A), (C), (D)). Gain or loss on depreciable business property and on business real property is business, so a IRC § 1231 loss survives. So does a casualty or theft loss allowable under IRC § 165(c)(2) or (3) — which covers a loss on property held for profit as well as a personal casualty within IRC § 165(h). But a retirement plan contribution made on behalf of a self-employed individual is expressly not business, so it reduces nothing.

The loss cannot feed on itself. no net operating loss deduction is allowed in computing the loss itself, so a carryover from an earlier year cannot enlarge the current year's loss^TY2026Verified 2026-08-21IRC § 172(d)(1), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(1)). A carryover from an earlier year is left out in computing the current year’s loss, which prevents a single bad year from compounding across a decade.

And capital losses are capped by capital gains. for a taxpayer other than a corporation, capital losses are deductible only to the extent of capital gains, and the IRC § 1202 exclusion is disallowed^TY2026Verified 2026-08-21IRC § 172(d)(2), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(2)). For a non-corporate taxpayer the ordinary allowance against other income is disregarded for this purpose, so a year whose only loss was a capital loss produces no net operating loss at all.

Then the carryover rules, which depend entirely on when the loss arose. a net operating loss arising in a taxable year beginning after 31 December 2017 is carried forward to each taxable year following the year of the loss, without limit; one arising before that date was carried to each of the 20 following years^TY2026Verified 2026-08-21IRC § 172(b)(1)(A)(ii), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(A)(ii)) and 80 percent — for a taxable year beginning after 31 December 2020 the deduction for losses arising after 2017 is capped at 80 percent of taxable income computed without the IRC § 172, § 199A and § 250 deductions; losses arising before 2018 are deducted first and are not capped^TY2026Verified 2026-08-21IRC § 172(a)(2), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(a)(2)) apply to a loss arising in a year beginning after 2017. A loss from an earlier year carries forward twenty years and is not capped, and IRC § 172(a)(2) directs that pre-2018 losses are absorbed first. A taxpayer carrying losses from both eras must track them separately.

Almost nobody has a carryback any more. The two survivors are a farming loss is carried back to each of the 2 taxable years preceding the year of the loss^TY2026Verified 2026-08-21IRC § 172(b)(1)(B)(i), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(B)(i)) and an insurance company other than a life insurance company keeps the older regime — a 2-year carryback and a 20-year carryforward^TY2026Verified 2026-08-21IRC § 172(b)(1)(C), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(C)) — and note what the second one does: it keeps both limbs of the older regime, so a non-life insurance company still has twenty years rather than an indefinite carryforward.

The waiver election is now a specialist provision. a taxpayer entitled to a carryback may elect to relinquish the entire carryback period, by the due date including extensions for the year of the loss, and the election is irrevocable for that year^TY2026Verified 2026-08-21IRC § 172(b)(3), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(3)). It only matters to a taxpayer who has a carryback, which since 2021 means a farmer or a non-life insurance company. A farmer with a good prior year usually wants the carryback; one whose prior years were also poor may prefer to waive it and keep the loss for the future, and the election must be made by the due date of the loss year’s return and cannot be undone.

Do not confuse the loss with the excess business loss. a loss disallowed as an excess business loss is treated as a net operating loss for the taxable year for the purpose of determining any IRC § 172(b) carryover to subsequent years^TY2026Verified 2026-08-21IRC § 461(l)(2), opened at law.cornell.edu/uscode/text/26/461 (IRC § 461(l)(2)) converts a disallowed excess business loss into a net operating loss. So a non-corporate taxpayer’s business loss can be reduced twice — once by the IRC § 172(d) modifications in computing it, and once by IRC § 461(l) before it is deductible — and what emerges from the second is a IRC § 172 loss subject to the cap.

How this has changed

Three regimes in nine years, and all three are still live.

Losses from years beginning before 2018. Twenty-year carryforward, two-year carryback, no percentage cap. These are approaching the end of their carryforward periods — a loss from a year beginning in 2017 expires after the year beginning in 2037 — but they are still the first losses absorbed under IRC § 172(a)(2)(A), and a taxpayer holding them should be careful not to let them lapse unused.

Losses arising in 2018, 2019 and 2020. IRC § 172(b)(1)(D), added by Pub. L. 116-136 § 2303, gave these a five-year carryback and suspended the percentage cap for years beginning before 2021. That relief has run out, but the paragraph remains in the statute and a reader meeting it may not notice it is spent.

Losses from years beginning after 2020. Indefinite carryforward, no general carryback, and the IRC § 172(a)(2) cap. This is the ordinary case and will be for the foreseeable future.

Nothing in Pub. L. 119-21 amended IRC § 172. The section reads for 2026 as it read for 2025. What changed around it is that IRC § 461(l) became permanent, so the route by which a non-corporate taxpayer’s business loss becomes a net operating loss is now a permanent feature rather than one due to expire — a loss disallowed as an excess business loss is treated as a net operating loss for the taxable year for the purpose of determining any IRC § 172(b) carryover to subsequent years^TY2026Verified 2026-08-21IRC § 461(l)(2), opened at law.cornell.edu/uscode/text/26/461 (IRC § 461(l)(2)) is the provision, and the loss limitations topic sets out the sequence.

One drafting point worth knowing. IRC § 172(a)(2)(B)(ii) computes the cap by reference to taxable income determined without the IRC § 172, IRC § 199A and IRC § 250 deductions. The IRC § 199A reference matters more than it did, because that section is now permanent too — the two provisions each exclude the other from their own base, and a preparer computing both must do so in the order the statutes set rather than iteratively.

Exam focus

Know the definition and know that it is not the accounting loss. The IRC § 172(d)(4) restriction on non-business deductions is the modification that comes up most, and it applies only to a non-corporate taxpayer.

Learn the three items IRC § 172(d)(4) hands back — depreciable and real business property, business and profit-seeking casualty losses — and the one it takes away, the self-employed retirement contribution.

Know that the carryover regime depends on the year the loss arose. Any question giving a year before 2018 is testing whether you apply the older rules.

Finally, know that a carryback survives only for farming and non-life insurance, and that the waiver election in IRC § 172(b)(3) is irrevocable and must be made by the due date of the loss year’s return.

Check yourself

1. An individual has a $150,000 business loss, $6,000 of dividend income and $20,000 of itemized deductions, all personal. What is her net operating loss?

Answer: $150,000. for a taxpayer other than a corporation, deductions not attributable to a trade or business are allowed only to the extent of gross income not derived from that trade or business^TY2026Verified 2026-08-21IRC § 172(d)(4), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(4)) allows the $20,000 of non-business deductions only to the extent of her $6,000 of non-business gross income, so $14,000 drops out of the computation and does not enlarge the loss.

2. A taxpayer’s only loss for the year is a $40,000 capital loss. Does he have a net operating loss?

Answer: No. for a taxpayer other than a corporation, capital losses are deductible only to the extent of capital gains, and the IRC § 1202 exclusion is disallowed^TY2026Verified 2026-08-21IRC § 172(d)(2), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(d)(2)) allows capital losses only to the extent of capital gains for this purpose, and he has none. The ordinary allowance against other income is disregarded in computing a net operating loss.

3. A property and casualty insurance company has a net operating loss in 2026. How is it carried?

Answer: Back two years and forward twenty. an insurance company other than a life insurance company keeps the older regime — a 2-year carryback and a 20-year carryforward^TY2026Verified 2026-08-21IRC § 172(b)(1)(C), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(1)(C)) keeps the pre-2018 regime for an insurance company other than a life insurance company — both limbs of it, so the carryforward is finite rather than indefinite.

4. A farming business wants to keep its 2026 loss for future years rather than carry it back. What must it do, and by when?

Answer: Elect to relinquish the entire carryback period. a taxpayer entitled to a carryback may elect to relinquish the entire carryback period, by the due date including extensions for the year of the loss, and the election is irrevocable for that year^TY2026Verified 2026-08-21IRC § 172(b)(3), opened at law.cornell.edu/uscode/text/26/172 (IRC § 172(b)(3)) requires the election by the due date, including extensions, for the 2026 return, and it is irrevocable for that year.

5. A corporation has $500,000 of pre-2018 loss and $900,000 of post-2020 loss carried to a year with $700,000 of taxable income before the deduction. How much does it deduct?

Answer: $700,000, and taxable income falls to nil. IRC § 172(a)(2)(A) takes the $500,000 pre-2018 loss first without any cap, leaving $200,000 of income. 80 percent — for a taxable year beginning after 31 December 2020 the deduction for losses arising after 2017 is capped at 80 percent of taxable income computed without the IRC § 172, § 199A and § 250 deductions; losses arising before 2018 are deducted first and are not capped^TY2026Verified 2026-08-21IRC § 172(a)(2), opened at law.cornell.edu/uscode/text/26/172 then caps the post-2020 loss by reference to the $700,000 base, a cap of $560,000, but only $200,000 of income remains — so $200,000 is used and $700,000 carries forward.