Are LLC Losses Tax Deductible? The Four Limits and Hobby Loss

LLC losses are generally tax deductible on your personal return, but only if your LLC is a pass-through entity and only after the loss survives four IRS limits applied in a fixed order: basis, at-risk, passive activity, and the excess business loss cap. For 2026, that final cap stops deductions at $256,000 for single filers and $512,000 for joint filers.¹ Anything blocked at an earlier stage never reaches the later ones, and anything blocked at the end usually carries forward rather than disappearing.

When an LLC Loss Can Reach Your Personal Return

Deductibility starts with how the IRS classifies your LLC. A single-member LLC is a disregarded entity, so the owner is taxed directly on all business income and losses.² A multi-member LLC defaults to partnership treatment, where the LLC itself pays no federal income tax and results pass through to the owners.³

An LLC can also elect S corporation or C corporation status by filing Form 8832 or Form 2553. An S election keeps pass-through treatment. A C election does not: losses stay locked inside the corporation and never flow to the owner’s Form 1040. If your LLC is taxed as a C corporation, the question of personal deductibility is moot until you sell or dissolve.

How the Loss Gets to Your 1040

Single-member LLCs report income and expenses on Schedule C. A net loss flows to Schedule 1 and reduces your adjusted gross income, offsetting wages, investment earnings, and other income on the same return.⁴

Multi-member LLCs taxed as partnerships file Form 1065 and issue each owner a Schedule K-1 showing their share of income or loss.⁵ The K-1 figure typically lands on the owner’s Schedule E. S corporations follow the same pattern with their own version of the K-1.

The Four Loss Limits, in Order

Getting a loss onto your return is only the entry point. The IRS requires you to test the loss against four separate rules in sequence: basis, then at-risk, then passive activity, then the excess business loss cap.⁶ The order is not optional, and a loss stopped early never gets a chance at the later filters.

Basis Limitation

You can only deduct losses up to your basis in the LLC. Basis is a running tally: cash and property you’ve contributed, plus income allocated to you over time, minus distributions taken and prior losses claimed. For a partnership-taxed LLC, the cap is your adjusted basis in your partnership interest at year-end.⁷ For an S corporation, it’s basis in your stock plus any money the company owes you personally.⁸

Losses above your basis are not lost. They carry forward indefinitely and become deductible when your basis rises through new contributions or future allocated income. A common trap: a loan taken out by the LLC itself does not always increase your personal basis, and the answer depends on entity type and loan structure.

At-Risk Rules

A loss that clears basis still has to clear the at-risk test. You are at risk for money you have personally invested and for borrowed amounts you are personally liable to repay or have secured with property not used in the business. Amounts protected by nonrecourse financing, guarantees, or stop-loss arrangements are specifically excluded.⁹

The practical effect is that losses funded by money someone else has to repay do not count. If your LLC borrowed $200,000 and no member personally guaranteed the note, that $200,000 generally does not add to your at-risk amount. Suspended at-risk losses carry forward to future years.

Passive Activity Rules

This is where most owners get stuck. If you do not materially participate in the business, your loss is passive and can only offset income from other passive sources such as rental properties or businesses you don’t actively run.¹⁰ Passive losses cannot offset wages, interest, or portfolio income.

The IRS provides seven material participation tests, and you only need to satisfy one.¹¹ The most commonly used is the 500-hour test: you worked in the activity for more than 500 hours during the year. Others cover situations where your work made up substantially all participation, where you worked at least 100 hours and no less than anyone else, and where you materially participated in five of the previous ten years.

The 500-hour test is also the one the IRS and Tax Court scrutinize most. Keep a contemporaneous log of your hours. Courts have repeatedly denied passive loss deductions when owners could offer only after-the-fact estimates of their time.¹²

Suspended passive losses carry forward and offset future passive income. When you sell your entire interest in the activity in a fully taxable transaction, any remaining passive losses from that activity are released and can offset any type of income.¹⁰

Excess Business Loss Cap

The final filter is the excess business loss rule. For 2026, single filers cannot deduct more than $256,000 in net business losses, and joint filers cannot deduct more than $512,000.¹ The thresholds adjust each year for inflation. Anything above the cap is not lost, but it converts to a net operating loss carryforward instead of a current-year deduction.¹³

The cap looks at your combined result across all businesses. Three LLCs, two profitable and one deep in the red, are netted together against the threshold. W-2 wages from a company you own are excluded from the calculation.¹⁴

What Happens to Losses Blocked by the Cap

A loss disallowed by the excess business loss rule becomes a net operating loss carried to the next year. Under current law, an NOL arising after 2017 can offset up to 80% of taxable income in the carryforward year, and there is no time limit on how long you can keep carrying it.¹⁵ The remaining 20% of taxable income is always taxed, no matter how large the accumulated NOL.

The 80% ceiling means large losses can take several years to fully absorb. An owner with $600,000 of disallowed loss and $200,000 of taxable income in the following year deducts only $160,000 that year and carries $440,000 forward again.

The Hobby Loss Gate

Before any of the four limits apply, the IRS can disallow your losses outright by treating the activity as a hobby. Activities not engaged in for profit cannot generate deductions exceeding the activity’s gross income for the year.¹⁶

The IRS presumes an activity is a legitimate business if it turned a profit in at least three of the last five tax years. For horse breeding and racing, the threshold is two out of seven.¹⁶ Falling short of the presumption is not fatal, but it shifts scrutiny to whether you operate in a businesslike way: separate books, changes in method aimed at profitability, dependence on the income, and relevant expertise. Persistent-loss side businesses with no marketing plan and no documented path to profitability are the ones auditors reclassify.

Two Side Effects Owners Miss

Self-Employment Tax

A net loss on Schedule C also wipes out self-employment tax on those earnings. If you run two businesses, the IRS combines net earnings across both when calculating self-employment tax.¹⁷ A $30,000 loss from one LLC offsets a $50,000 profit from another, so self-employment tax applies only to $20,000. A year with zero net self-employment income also means no Social Security credits built for that year, which matters if you’re relying on steady accumulation toward benefits.

QBI Deduction

Pass-through owners generally qualify for the 20% qualified business income deduction under Section 199A. A loss year produces negative QBI, which does not generate a deduction but does carry forward to reduce positive QBI in future years.¹⁸ With multiple businesses, negative QBI from one must first offset positive QBI from the others in the current year, shrinking the total eligible for the 20% deduction.

Any remaining negative QBI carries forward indefinitely and is allocated proportionally against positive QBI businesses in future years.¹⁸ A bad year in one LLC can therefore drag on the QBI deduction from a profitable LLC for several years, and the IRS requires you to track the carryforward separately on a FIFO basis.

1
Internal Revenue Service. Rev. Proc. 2025-32
2
Internal Revenue Service. Single Member Limited Liability Companies
3
Internal Revenue Service. LLC Filing as a Corporation or Partnership
4
Internal Revenue Service. Instructions for Schedule C (Form 1040) (2025)
5
Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) (2025)
6
Internal Revenue Service. Instructions for Form 461
7
Office of the Law Revision Counsel. 26 USC 704 – Partner’s Distributive Share
8
Office of the Law Revision Counsel. 26 USC 1366 – Pass-Thru of Items to Shareholders
9
Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk
10
Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
11
Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules
12
Taxpayer Advocate Service. Most Litigated Issues – Passive Activity Loss Under IRC 469
13
Internal Revenue Service. Instructions for Form 461 (2025)
14
Cornell Law School. 26 USC 461(l)(3) – Excess Business Loss Definition
15
Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction
16
Office of the Law Revision Counsel. 26 USC 183 – Activities Not Engaged in for Profit
17
Internal Revenue Service. 2025 Instructions for Schedule SE (Form 1040)
18
Internal Revenue Service. Instructions for Form 8995 (2025)