Business Tax Preparation · Business expenses, deductions and credits

Net operating loss deduction

Verification 2026 Verified
tax year · reviewed 2026-08-21 · Draft for I. Ohu review

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)^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (IRC § 172(b)(3)).

Current figures

Item	Rule	Authority
Net operating loss, defined	the excess of the deductions allowed by chapter 1 over gross income, computed with the modifications in IRC § 172(d)^TY2026	IRC § 172(c)
No deduction for 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^TY2026	IRC § 172(d)(1)
Capital losses	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^TY2026	IRC § 172(d)(2)
Non-business deductions	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^TY2026	IRC § 172(d)(4)
What is treated as business	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^TY2026	IRC § 172(d)(4)(A), (C), (D)
Carryforward	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^TY2026	IRC § 172(b)(1)(A)(ii)
The cap on the deduction	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^TY2026	IRC § 172(a)(2)
Farming carryback	a farming loss is carried back to each of the 2 taxable years preceding the year of the loss^TY2026	IRC § 172(b)(1)(B)(i)
Non-life insurance companies	an insurance company other than a life insurance company keeps the older regime — a 2-year carryback and a 20-year carryforward^TY2026	IRC § 172(b)(1)(C)
Waiver election	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^TY2026	IRC § 172(b)(3)
Excess business loss becomes one	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^TY2026	IRC § 461(l)(2)

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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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.

The loss on the return and the loss in the statute

An unmarried sole proprietor has a $210,000 loss from her business, $9,000 of interest income, and $31,000 of itemized deductions, of which $4,000 is investment interest and the rest is personal. Her return shows negative taxable income of $232,000.

the excess of the deductions allowed by chapter 1 over gross income, computed with the modifications in IRC § 172(d)^TY2026 (IRC § 172(c)) starts from deductions over gross income and then applies the modifications.

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^TY2026 (IRC § 172(d)(4)): her non-business deductions of $31,000 are allowed only against her non-business gross income of $9,000. So $22,000 of them drops out.

Her net operating loss is $210,000, not $232,000. The $22,000 difference is real money she has spent and cannot carry anywhere — it is consumed in a year with no income to absorb it and is gone.

Now add a fact: she also has a $40,000 loss on the sale of business machinery. 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^TY2026 (IRC § 172(d)(4)(A)) treats gain or loss on depreciable business property as attributable to the trade or business, so the whole $40,000 enters the loss and it becomes $250,000. Had the loss been on shares instead, 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^TY2026 would have capped it at her capital gains, which are nil.

Two vintages of loss in one year

A corporation carries forward $600,000 of net operating loss from a year beginning in 2016 and $2,400,000 from a year beginning in 2022. In 2026 its taxable income before any net operating loss deduction is $1,500,000.

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^TY2026 (IRC § 172(a)(2)) sets the order. The pre-2018 loss is taken first under IRC § 172(a)(2)(A) and is not capped, so the whole $600,000 is used, leaving $900,000 of taxable income.

The post-2017 loss is then limited by IRC § 172(a)(2)(B)(ii) to a share of taxable income computed without the IRC § 172, § 199A and § 250 deductions — that base is $1,500,000, so the cap is $1,200,000. But only $900,000 of income remains, so $900,000 is used.

Taxable income is nil, $1,500,000 of loss has been absorbed, and $1,500,000 of the 2022 loss carries forward indefinitely.

Reverse the order — apply the capped loss first — and the answer changes: the cap would consume $1,200,000 and leave $300,000 of income against which the uncapped pre-2018 loss could be used, so $1,500,000 is still absorbed but $300,000 of the more valuable uncapped loss is spent unnecessarily. The statutory order protects the taxpayer.

The farmer who waived

A farming business has a $400,000 net operating loss in 2026. Its 2024 and 2025 were also loss years. It expects a very profitable 2027 after a change of crop.

a farming loss is carried back to each of the 2 taxable years preceding the year of the loss^TY2026 (IRC § 172(b)(1)(B)(i)) gives it a two-year carryback to 2024 and 2025 — both of which had no income to absorb anything, so the carryback is worthless and the loss would sit unused in those years’ computations.

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^TY2026 (IRC § 172(b)(3)) lets it relinquish the entire carryback period. The whole $400,000 then carries forward indefinitely under 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^TY2026 and is available against 2027’s profits, subject to 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^TY2026.

Two conditions on the election matter. It must be made by the due date, including extensions, for the 2026 return — so it cannot be reconsidered when 2027’s results are known. And it is irrevocable for that year.

The election is not free of cost: the 80 percent cap applies to the carryforward and would not have applied to a carryback to a pre-2018 year. Here that is academic, since 2024 and 2025 have no income, but on other facts it is the whole question.

Traps.

A net operating loss is not the negative figure on the return. {fig:nol.mod_nonbusiness} (IRC § 172(d)(4)) strips out non-business deductions above non-business income, and the difference is lost.

A capital loss produces no net operating loss on its own. {fig:nol.mod_capital} (IRC § 172(d)(2)) caps it at capital gains and disregards the ordinary allowance.

The carryover rules depend on the year the loss arose, not the year it is used. Losses from years beginning before 2018 have twenty years and no cap; later ones have no expiry and a cap.

Pre-2018 losses are used first. IRC § 172(a)(2)(A) takes them before the capped losses, which is to the taxpayer's advantage.

Two carrybacks survive, and one of them keeps the old carryforward too. {fig:nol.insurance_carryback} (IRC § 172(b)(1)(C)) gives a non-life insurance company two years back and twenty forward, not an indefinite carryforward.

A self-employed retirement contribution is not a business deduction here. IRC § 172(d)(4)(D) excludes a IRC § 404 deduction made on behalf of a self-employed individual from the items treated as attributable to the trade or business.

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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 (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^TY2026 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.

Change log

2026-08-21Initial draft. Sets out the IRC § 172(c) definition and the IRC § 172(d) modifications that make a net operating loss different from a book or economic loss, in particular the IRC § 172(d)(4) restriction on non-business deductions of a non-corporate taxpayer and the items IRC § 172(d)(4)(A), (C) and (D) do and do not treat as attributable to the trade or business. Records the three carryover regimes since 2017, the IRC § 172(b)(1)(C) survival of the older rules for a non-life insurance company, and the IRC § 172(b)(3) waiver election that most taxpayers no longer need.