A bonus depreciation carry forward isn’t really a depreciation carry forward at all. When your bonus depreciation deduction exceeds your taxable income for the year, the excess becomes a net operating loss, and it’s that NOL that moves forward to future tax years. Under current federal law, the NOL carries forward indefinitely and can offset up to 80% of your taxable income in any year you use it, until the balance is fully absorbed.1Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction Several other rules can delay or trap the loss before it ever gets that far, and state treatment often diverges sharply from what happens on your federal return.
How the Loss Actually Moves Forward
Suppose you buy a $500,000 piece of equipment and deduct the full cost under bonus depreciation. Your business produced $300,000 in gross income that year. After the depreciation and your other deductions, you’re sitting on a $200,000 net operating loss. Losses arising in tax years beginning after December 31, 2017 carry forward indefinitely under Section 172.1Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction
Carrybacks are generally eliminated for non-farming businesses. You can’t take a bonus-depreciation-driven loss and apply it to a prior year for a refund. The loss only moves forward.
The 80% Income Cap
When you use the carry forward in a profitable year, the NOL deduction is capped at 80% of your taxable income for that year, calculated before the NOL deduction itself and without regard to the qualified business income deduction under Section 199A.1Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction You’ll owe tax on at least 20% of your income in any year you draw on the carry forward.
Say you carry $400,000 of NOL into next year and earn $300,000. You can use $240,000 of the NOL (80% of $300,000), leaving $60,000 of taxable income. The remaining $160,000 rolls to the following year. That process repeats until the loss is exhausted.
Limits That Can Trap the Loss First
Before a bonus depreciation loss ever becomes a usable NOL on your personal return, it may run into several stacked limitations. If your business is a partnership or S corporation, the loss shows up on your Schedule K-1, but a series of gates decides how much of it you can actually deduct this year. What gets suspended at these gates isn’t an NOL. It’s a suspended loss held at the level of the specific rule that blocked it, released only when that rule’s conditions change.
Basis Limitation
A partner can only deduct their share of partnership losses up to their adjusted tax basis in the partnership at year-end.2Office of the Law Revision Counsel. 26 USC 704 – Partner’s Distributive Share If the partnership claims $1 million in bonus depreciation and your 50% share produces a $500,000 loss, but your basis is only $200,000, you deduct $200,000 now. The remaining $300,000 is suspended and carries forward as long as you stay a partner. You unlock it by contributing capital, receiving income allocations, or increasing your share of partnership liabilities. If you dispose of your entire partnership interest while a loss is still suspended under the basis rule, that deduction is lost permanently.
S corporation shareholders face a parallel rule. Deductible losses can’t exceed your adjusted basis in the corporation’s stock plus any direct loans you personally made to the company.3Office of the Law Revision Counsel. 26 USC 1366 – Pass-Thru of Items to Shareholders Third-party loans to the S corporation, including bank financing on the equipment purchase itself, do not give you basis.
At-Risk Limitation
Any loss that clears the basis gate still has to pass the at-risk limitation under Section 465. You’re at risk only for money you’ve personally invested or personally guaranteed. Non-recourse financing from anyone other than the seller generally doesn’t count, with a narrow exception for certain real estate loans from qualified lenders. Losses that exceed your at-risk amount are suspended and released when your at-risk amount increases.
Passive Activity Losses
If the property is used in an activity in which you don’t materially participate (rental real estate is the common example), the loss faces the passive activity rules. Passive losses can only offset passive income. A disallowed passive loss carries forward and is treated as a deduction from that same activity in the following year.4Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited It can’t reach your wages, income from a business you actively run, or investment income. The loss stays locked until you generate passive income to absorb it, or you sell the entire activity in a fully taxable transaction, at which point remaining suspended losses release against all income.
The order matters. Basis first, then at-risk, then passive activity. A loss that survives the first two gates can still be frozen at the third.
Excess Business Loss Limitation
Non-corporate taxpayers face one more cap under Section 461(l). If your total net business losses for the year exceed an inflation-adjusted threshold, the excess is disallowed for the current year.5Internal Revenue Service. Excess Business Losses The base threshold is $250,000 for single filers and $500,000 for joint filers, adjusted annually.6Legal Information Institute. 26 U.S. Code 461(l)(3) – Excess Business Loss Definition
The disallowed amount doesn’t disappear. It converts into an NOL carry forward, which then has to work through the standard 80% cap when you use it. In practical terms, this rule pushes a portion of a large bonus depreciation benefit at least one year down the road, and potentially longer if the converted NOL keeps bumping against the cap.
Calculating and Documenting the Carry Forward
The NOL you carry forward is not simply the negative number at the bottom of your return. Adjustments apply. You cannot include the qualified business income deduction under Section 199A or the Section 250 deduction when computing the NOL for the loss year.1Office of the Law Revision Counsel. 26 U.S. Code 172 – Net Operating Loss Deduction These adjustments keep the NOL tied to actual business losses rather than being inflated by unrelated deductions.
Individuals, estates, and trusts compute the NOL and the amount available for carry forward on Form 172.7Internal Revenue Service. Instructions for Form 172 – Net Operating Losses for Individuals, Estates, and Trusts The IRS expects a year-by-year schedule showing the original NOL, how much you used in each subsequent year, and the running balance. Reconstructing that schedule years later from incomplete records during an audit is not something you want to attempt.
Hold on to everything supporting the original bonus depreciation claim: purchase invoices, placed-in-service dates, and the cost basis calculation. Keep records for at least three years after you fully exhaust the carry forward.8Internal Revenue Service. Publication 536 – Net Operating Losses (NOLs) for Individuals, Estates, and Trusts For a large NOL that takes a decade to absorb, that means holding documentation for 13 years or more from the original purchase.
State Treatment Often Doesn’t Match
Federal and state returns often disagree sharply when bonus depreciation is in the picture. Many states decouple from federal bonus depreciation, allowing only standard MACRS depreciation on the state return even when you deducted 100% federally. Your state NOL will be much smaller than the federal one, or may not exist at all.
A business with a $1 million federal NOL from bonus depreciation might still owe state tax on $100,000 or more of state taxable income because the state only allowed $50,000 in regular depreciation. That means running separate depreciation schedules and separate NOL tracking for each state where you file. Even conforming states sometimes impose their own percentage limits or cap the carry forward period at a set number of years instead of allowing indefinite carry forward. Confirm your state’s conformity status each year, because states update their conformity dates on their own schedules.
When Electing Out Makes More Sense
Taking bonus depreciation isn’t mandatory. You can elect out for any class of property placed in service during the tax year, but the election applies to every asset in that class for that year; you cannot pick and choose within the class.9Internal Revenue Service. Additional First Year Depreciation Deduction (Bonus) – FAQ The election is made by filing a statement with Form 4562 by the due date, including extensions, of the return for the year the property was placed in service.
There’s also a middle option under the One Big Beautiful Bill Act amendments: a reduced 40% bonus depreciation rate in place of 100% for qualified property placed in service in your first tax year ending after January 19, 2025.10Internal Revenue Service. Notice 2026-11 – Interim Guidance on Additional First Year Depreciation Deduction Under Section 168(k)
Electing out often makes sense when you expect materially higher income in future years and would rather have regular depreciation deductions offset income taxed at a higher marginal rate; when you’re already in a loss position and additional deductions just pile onto an NOL capped at 80% of future income; or when state decoupling means the federal deduction creates a timing mismatch with no corresponding state benefit. Running the numbers before you file is a lot cheaper than living with a carry forward you never really wanted.