A net operating loss on Form 1040 is what remains after you take your negative taxable income and strip out the items the tax code won’t let contribute to a business loss: prior-year NOL deductions, the qualified business income deduction, non-business deductions in excess of non-business income, and most non-business capital losses. What’s left, if it’s still negative, is your NOL, and for losses arising after 2020 it carries forward indefinitely against no more than 80% of taxable income in any future year.1Internal Revenue Service. Instructions for Form 172 Getting the number right matters because any error compounds across every carryforward year.
What Qualifies as an NOL
An NOL has to come from business activity. The most common sources on an individual return are losses from a sole proprietorship (Schedule C), rental real estate or partnership and S corporation losses that flow through to you (Schedule E), and farming (Schedule F).2Internal Revenue Service. Publication 536 – Net Operating Losses for Individuals, Estates, and Trusts
The line between business and non-business items runs through the whole calculation. Business income and deductions are what you report on Schedules C, E, and F. Non-business income is things like interest, dividends, and non-business capital gains. Non-business deductions include the standard deduction and most itemized deductions such as personal medical expenses and mortgage interest on your home. Non-business deductions can offset non-business income, but any excess cannot enlarge your NOL.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction Personal spending isn’t allowed to inflate a business-generated loss.
Loss Limitations That Apply Before the NOL Calculation
Several loss rules run before you get to the NOL step. The IRS requires them in this order:4Internal Revenue Service. Publication 925, Passive Activity and At-Risk Rules
- Basis limitations. You can’t deduct partnership or S corporation losses beyond your tax basis in the entity. Anything above basis is suspended until basis increases.
- At-risk limitations. Losses from an activity are capped at the amount you have at risk, generally your cash investment plus amounts you borrowed and are personally liable for.
- Passive activity limitations. Losses from passive activities, which for most taxpayers includes rentals, can only offset passive income. Unused passive losses carry forward.
- Excess business loss limitation. Whatever business loss survives the first three filters faces one more cap before it can offset non-business income.
Only losses that clear all four filters enter the NOL calculation.
The Excess Business Loss Cap for 2026
The excess business loss rule caps how much net business loss you can deduct against non-business income like wages, interest, or dividends in a single year. It applies to all non-corporate taxpayers, including sole proprietors, partners, and S corporation shareholders, and you compute it on Form 461.5Internal Revenue Service. About Form 461, Limitation on Business Losses
For 2026, the threshold is $256,000 for single filers and $512,000 for married couples filing jointly.6Internal Revenue Service. Revenue Procedure 2025-32 If your business deductions exceed your business income by more than the threshold, the excess is disallowed in the current year and becomes an NOL carryforward to the next year.7Internal Revenue Service. Instructions for Form 461
Turning Negative Taxable Income Into an NOL
A negative number on Line 15 of your Form 1040 doesn’t automatically equal an NOL. You have to adjust that figure by adding back items the tax code excludes from the loss. Form 172 contains the worksheets that walk you through it.1Internal Revenue Service. Instructions for Form 172
Required Add-Backs
Starting from your negative taxable income, add back:
- Any NOL deduction from a prior year that you claimed on this year’s return. You are measuring the loss generated this year, so a prior carryforward can’t inflate it.
- The Section 199A qualified business income deduction. It’s an income-based deduction, not an actual expense, and it comes back in full.1Internal Revenue Service. Instructions for Form 172
- Non-business deductions in excess of non-business income. Because the standard deduction is a non-business deduction, taxpayers who claim it generally add the entire amount back. Itemizers add back only the portion of non-business deductions above their non-business income.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction
The standard-deduction add-back catches most filers off guard. If your taxable income is negative $50,000 and you took the standard deduction, that deduction amount comes right back out of the NOL, shrinking the final figure.
Capital Loss Rules
Capital losses get their own treatment. Non-business capital losses can only offset non-business capital gains. Business capital losses can only offset business capital gains. Any net capital loss beyond the opposing gains is excluded from the NOL computation.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction One exception worth flagging: gains and losses on depreciable business property and business real estate (Section 1231 assets) count as business items for this purpose, even though they get capital gain treatment elsewhere.
If the adjusted result is still negative, that’s your NOL. If the add-backs push it to zero or positive, you have no NOL for the year even though your taxable income was negative.
Using the NOL in Future Years
NOLs from tax years after 2020 carry forward indefinitely. There’s no expiration, and for most taxpayers there’s no carryback.1Internal Revenue Service. Instructions for Form 172
The 80% Taxable Income Limit
When you apply an NOL against a later year’s income, the deduction can’t erase your tax bill entirely. For losses arising after December 31, 2017, the deduction is capped at 80% of taxable income, computed without the NOL deduction itself, the QBI deduction, or the Section 250 deduction.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction At least 20% of your future taxable income remains subject to tax regardless of how large your carryforward balance is.
If you still have any pre-2018 NOL on the books, that older loss is applied first and can wipe out 100% of taxable income. The 80% cap then applies only to the post-2017 portion, calculated against what’s left.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction Any NOL amount that hits the 80% cap and can’t be used simply rolls to the next year, where the same limitation applies again.
The Farming Carryback
Farming losses are the main carryback exception. The portion of your NOL attributable to farming income and deductions can go back two years.3Office of the Law Revision Counsel. 26 US Code 172 – Net Operating Loss Deduction A farming loss is what your NOL would have been if only farming items were counted. In a year with both farming and non-farming losses, only the farming slice qualifies. You can elect to waive the carryback and carry the farming loss forward instead; the election must be made by your return’s due date including extensions, and once made it’s irrevocable.
Reporting the Deduction on Your Return
When you carry an NOL forward, enter it on Schedule 1 (Form 1040), Line 8a, as a negative number in parentheses. Line 8a sits under Part I (Additional Income) and reduces the total that flows into your adjusted gross income on Form 1040.8Internal Revenue Service. Schedule 1 (Form 1040) – Additional Income and Adjustments to Income
Complete Form 172 to document the NOL calculation and attach it to your return. Form 172 runs through the statutory modifications and produces the official NOL figure available for carryback or carryforward.1Internal Revenue Service. Instructions for Form 172 Keep a running schedule showing the original NOL, how much was absorbed each year, and the remaining balance.
Claiming a Farming Carryback Refund
If you have an eligible farming loss and want to carry it back, you have two routes:
- Form 1045, Application for Tentative Refund. Faster processing: the IRS acts within 90 days from the later of the date you file or the last day of the month that includes your return’s due date. The deadline is tight. You must file Form 1045 within one year after the end of the loss year, and once that window closes this option is gone.9Internal Revenue Service. Instructions for Form 104510Internal Revenue Service. Instructions for Form 1045
- Form 1040-X, Amended Return. File an amended return for each prior year to which you carry the loss. Slower, but available after the Form 1045 window closes, subject to the normal refund statute of limitations.11Internal Revenue Service. Form 1040-X – Amended US Individual Income Tax Return
Attach a completed Form 172 either way.
Two Things That Catch Filers Off Guard
Self-employment tax isn’t reduced. An NOL carryforward reduces your income tax, but not your net earnings from self-employment. Section 1402(a)(4) excludes the NOL deduction from the self-employment income calculation.12Office of the Law Revision Counsel. 26 US Code 1402 – Definitions You still owe the full 15.3% self-employment tax on your current-year business earnings even while deducting a prior-year NOL against your income tax.
State rules often diverge. Many states don’t fully conform to the federal NOL rules. Some impose shorter carryforward periods, different percentage limits, or dollar caps. Check your state’s conformity before assuming a federal carryforward translates dollar-for-dollar to your state return.
Records to Keep
An NOL carryforward can stay with you for years, sometimes decades. The IRS requires you to keep records for any tax year that generates an NOL for three years after the carryforward is fully used up or expires.13Internal Revenue Service. Instructions for Form 172 – Net Operating Losses for Individuals, Estates, and Trusts That means holding onto the original return, the Form 172 or worksheet showing the computation, and each subsequent year’s return that used part of the deduction. A six-figure NOL spread over ten years needs every link in that chain documented and accessible.