Key Takeaways
- Section 461(l) caps how much business loss you can use in one year. That includes large first-year losses from oil and gas drilling investments and cost segregation studies. The cap limits how much of that loss you can deduct against wages and investment income.
- The 2026 cap is lower than the 2025 cap. For 2026, it’s $256,000 for single filers and $512,000 for married couples filing jointly. Inflation-adjusted figures usually rise, but a change in the One Big Beautiful Bill Act explains the drop.
- Clearing the passive activity rules doesn’t settle the question. This cap applies only after three other loss limits.
- A large salary doesn’t raise the cap. The disallowed amount, meaning the part of the loss over the cap, still has value, but a second limit controls how fast you can use it.
- Georgia doesn’t follow every federal change to this rule. Your Georgia result can differ from your federal one.
“Why didn’t my whole deduction count this year?” We hear that question often in year-end planning. It usually comes from investors in oil and gas drilling programs or from property owners who had a cost segregation study done. A cost segregation study is an engineering review that lets you depreciate parts of a building faster. Both investments can create a large first-year deduction, and the same federal limit applies to both.
In an oil and gas drilling program, investors pay to drill wells and share in any oil or gas produced. Most drilling costs can be deducted in the first year, so the investment creates a large tax loss right away. On the real estate side, you might buy a rental property and order a cost segregation study for it. You can then depreciate parts that wear out faster, such as flooring and fixtures, over fewer years.
When a Large Deduction Doesn’t Fully Count
In both cases, the first-year deduction is often larger than the income the investment brings in. The difference is a business loss, and you’d normally expect it to lower the tax on your other income, such as your salary. Then your tax return comes back. Part of the loss didn’t reduce this year’s tax at all. Instead, it moved into a carryforward, which is an amount you can only use in a future year.
That result usually traces to Section 461(l) of the Internal Revenue Code, known as the excess business loss limitation. Most investors don’t hear about this rule until it reduces a deduction they had counted on. Our breakdown of percentage depletion and oil and gas deductions covers the rules that apply before this one.
What Is the Excess Business Loss Limitation?
For this rule, the tax code sorts your income into two groups. Business income comes from businesses you own or run, such as a sole proprietorship, a partnership, an S corporation, or a rental you operate. Nonbusiness income is everything else, including wages, interest, dividends, and gains on your investments.
Section 461(l) limits how much of a net business loss can offset your nonbusiness income in one year. “Net” means the combined result of all your businesses, so a profit in one business shrinks a loss in another. Only a set amount of that total can reduce your nonbusiness income each year.
The limit applies to individuals, trusts, and estates, which covers every taxpayer except a C corporation. Owners of a partnership or an S corporation are covered too. These businesses don’t pay income tax themselves, so their profits and losses pass through to each owner’s personal return. The limit applies there.
How the Cap Works in Practice
Each year, the IRS sets a threshold amount for each filing status. The calculation adds up your business deductions and compares them with your business income plus that threshold. If your deductions are larger, the difference is your excess business loss. That amount is disallowed, meaning you generally can’t deduct it this year. The IRS uses Form 461 for the calculation.
A simple example shows how this works. Say you file as single in 2026, with $400,000 of wages and a $300,000 net business loss. The 2026 single threshold is $256,000, so $256,000 of the loss can reduce your wages. That leaves $44,000 as your excess business loss, which carries forward to 2027.
In What Order Do the Loss Rules Apply?
The excess business loss cap isn’t the only rule that can shrink a loss. A business loss passes through four limits in a fixed order, and Section 461(l) comes last. Each earlier limit can delay part of the loss before the next one applies.
- Basis limits. You can deduct losses only up to your basis in the business. Basis is generally the money you’ve invested plus your share of certain debt. Section 1366(d) sets this rule for S corporation shareholders, while Section 704(d) sets it for partners. A loss above your basis waits until your basis increases, for example when you invest more.
- At-risk rules. Section 465 limits your loss to the amount you could actually lose. That usually means the money you put in plus debt you’re personally liable to repay. Nonrecourse financing, meaning a loan the lender can collect only from the property, often doesn’t count.
- Passive activity rules. A passive activity is a business you invest in but don’t regularly work in, such as most rentals. Under Section 469, a passive loss can offset only passive income, not wages. For oil and gas, a direct working interest, meaning you share in drilling costs and liability, often makes the loss nonpassive. For a short-term rental, the usual test is material participation. That means you work in the rental on a regular, continuous, and substantial basis.
- The excess business loss limit. Only the loss left after the first three steps reaches Section 461(l), where the annual cap applies.
Many investors assume a loss is fully deductible once it clears the passive rules. For a large loss, though, the excess business loss cap often sets the final number. Our guide to oil and gas passive activity and at-risk rules covers steps two and three in more detail.
Why Did the Cap Drop for 2026?
For several years, the excess business loss limitation carried an expiration date. The One Big Beautiful Bill Act (OBBBA), signed July 4, 2025, removed that date and made the limit permanent.
OBBBA also changed how the cap adjusts for inflation. The law has always started from $250,000 for single filers and $500,000 for joint filers. Through 2025, those amounts grew with inflation measured from 2017, which is how the cap reached $313,000 and $626,000. OBBBA now starts the measurement from 2024 instead, so that growth restarted from a much lower point.
Does a High Salary Raise the Cap?
No. It’s easy to assume a large salary leaves room for a larger business loss, since there’s more income for the loss to offset. However, the calculation compares your business losses only with your business income. Wages reported on Form W-2 count as nonbusiness income, so they don’t raise the cap.
Consider a physician who earns $900,000 in wages, files jointly, and has an $800,000 business loss with no business income. The salary is large enough to cover the whole loss. Even so, only $512,000 of the loss can offset it this year, and $288,000 carries forward.
What Happens to the Disallowed Loss?
The amount over the cap is disallowed for the year, but you don’t lose it. Under Section 461(l)(2), it becomes a net operating loss (NOL). An NOL is a loss too large to use in the year it happens. It carries forward to reduce taxable income in later years. From then on, it follows the general NOL rules in Section 172.
Those rules add a second limit. An NOL from 2018 or later can generally offset only 80% of your taxable income in the year you use it. For example, if your 2027 taxable income is $200,000, the NOL can reduce it by up to $160,000. So a large disallowed loss can take several years to use up, and you receive the tax benefit gradually.
A Worked Example: When Timing Changes the Result
Picture a married couple in Atlanta, GA, filing jointly for 2026. They earn wages and investment income but have no business income this year. They invest in a drilling program through a working interest and deduct $600,000 of intangible drilling costs. Those are the labor, fuel, and other drilling costs with no salvage value. That’s why they can usually be deducted right away. The couple also owns a short-term rental they materially participate in, and a cost segregation study gives it a $200,000 loss.
Their total business loss is $800,000. The 2026 joint cap lets $512,000 of it reduce their wages and investment income. The remaining $288,000 becomes an NOL carried to 2027. In 2027, it can offset no more than 80% of their taxable income.
What Changes With Different Timing
Now suppose the couple makes one decision differently. They split their drilling investment across two programs, one that starts drilling in 2026 and one that starts in 2027. That puts $300,000 of drilling costs in 2026, so their 2026 business loss totals $500,000. Because that total is under the $512,000 cap, they can use the full loss this year.
The other $300,000 becomes part of their 2027 business loss. As a current-year loss, it isn’t subject to the 80% NOL limit. Instead, it can offset their 2027 nonbusiness income up to the 2027 cap.
Both versions are compliant choices about when an investment starts. In both, the couple deducts the same $800,000 over time. The trade-off is that half the drilling deduction waits a year, so the right split depends on their income in each year. A deduction saves more tax in a year when your tax rate is higher, which is the idea behind planning a spike year.
Prepaid drilling costs follow a narrower rule. If you pay before drilling begins, that payment usually counts in the year paid under one condition. Drilling has to start within 90 days after year-end. So the actual drilling dates matter as much as the payment dates.
These figures are illustrative. Before you commit to an investment, our CPAs at Fusion can model your personal tax return against each limit.
How Does Georgia Treat the Excess Business Loss Limit?
Section 461(l) is a federal rule, and each state decides how closely to follow it. Every year, Georgia passes a conformity law that chooses which federal tax rules the state adopts. Its 2026 version, House Bill 1199, largely keeps the excess business loss limit. However, it tells Georgia to disregard certain federal changes to the rule.
One of those is a 2020 change from the Coronavirus Aid, Relief, and Economic Security (CARES) Act. That federal rule spelled out that wages don’t count as business income in this calculation. Because Georgia disregards it, the disallowed amount on your Georgia return can differ from your federal figure. Over time, your federal and Georgia carryforward balances can also end up different, so your CPA tracks them separately. Georgia revisits conformity every year, so the current-year position is worth confirming before you file.
How Fusion CPA Can Help
A large loss raises two questions: how much clears each limit, and which year each piece belongs in. Our CPAs at Fusion work through both with real estate investors and energy investors before the investment closes. That work includes tracking basis and at-risk amounts and modeling the federal cap against your projected income. We also coordinate cost segregation studies through an engineering partner and apply the results to your return.
For clients in Atlanta, GA, the work includes a separate Georgia calculation. For those filing in several states, our multi-state tax team checks each state’s conformity position.
This limit is a timing question, and timing is easiest to plan before December 31. If you’re weighing a drilling investment or a cost segregation study, Schedule a Discovery Call with our team to tackle year-round tax strategy and keep you ahead of the timing.
We’ll walk through where your loss falls and what the carryforward looks like. You can also reach Fusion CPA at info@fusiontaxes.com or 404-955-7338.
Sources
- Internal Revenue Code Section 461(l), including the wage exclusion in Section 461(l)(3)(A) and the carryover rule in Section 461(l)(2).
- Revenue Procedure 2025-32, 2026 inflation-adjusted excess business loss thresholds.
- Public Law 119-21 (the One Big Beautiful Bill Act), Section 70601.
- Internal Revenue Code Sections 1366(d), 704(d), 465, and 469.
- Internal Revenue Code Sections 172(a) and 461(i).
- Georgia House Bill 1199 (2026), amending O.C.G.A. Section 48-1-2.
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About the author
Trevor McCandless, CPA, MTax is the founder and CEO of Fusion CPA, a tax, outsourced accounting, and advisory firm serving business owners and high-achieving individuals across 40+ states from offices in Atlanta GA, Tampa FL, San Juan Puerto Rico, and Park City Utah. He works with owners on entity structure, owner compensation, and the multi-state exposure that arrives quietly with a growing team.
