A tax loss from an earlier income year is a deduction the tax code lets you carry into a later return when your allowable expenses exceeded your income in the year the loss arose. Federal law calls this a net operating loss (NOL) under Section 172, and it lets you reduce a profitable year’s taxable income using red ink from a previous year.1Office of the Law Revision Counsel. 26 USC 172 – Net Operating Loss Deduction How much of it you can use, how long it lasts, and what kind of income it can offset all depend on the type of loss and the year it originated.
How a Prior-Year Loss Comes Into Existence
A tax loss forms when total allowable deductions for a year exceed total income for that same year. A failed venture, a bad rental year, a large depreciation deduction, or investment losses can all push a return into negative territory. That negative result is quantified on your return for the loss year and becomes a balance you track going forward. The IRS does not track it for you; the recordkeeping burden is yours from the year of the loss through every year you use any portion of it.
The Three Kinds of Losses Individuals Carry Forward
Not every loss behaves the same way. The category determines what income it can offset, how much you can use per year, and how long you have to use it.
Business and Operating Losses
These are the most flexible. When ordinary business expenses — payroll, rent, supplies, depreciation — exceed business revenue, the resulting deficit can offset most types of ordinary income, including wages, interest, and self-employment earnings. Sole proprietors, partners, and S corporation shareholders all see these flow through to their personal returns. This is the classic NOL.
Capital Losses
Capital losses come from selling investment assets for less than you paid. They first offset any capital gains from the same year. If losses still exceed gains after that netting, you can deduct up to $3,000 of the excess against ordinary income ($1,500 if married filing separately).2Internal Revenue Service. Topic No. 409, Capital Gains and Losses Any remaining capital loss carries forward indefinitely, subject to that same annual cap. Someone sitting on $30,000 in unused capital losses will be chipping away $3,000 at a time for a decade.
If you invested in qualifying small business stock under Section 1244, you can treat up to $50,000 of losses as ordinary losses ($100,000 on a joint return) rather than capital losses. That bypasses the $3,000 cap and offsets ordinary income dollar-for-dollar in the year you sell.
Passive Activity Losses
Rental property and limited partnership interests generate passive losses, and those can only offset passive income — not wages, not portfolio income.3Office of the Law Revision Counsel. 26 U.S. Code 469 – Passive Activity Losses and Credits Limited Any portion you can’t use in the current year carries forward automatically and sits there until you generate passive income or sell the property.
There is a partial exception for rental real estate when you actively participate in managing it. In that case, you can deduct up to $25,000 of rental losses against non-passive income, but the allowance phases out once modified adjusted gross income exceeds $100,000 and disappears at $150,000. When you sell your entire interest in a passive activity in a fully taxable transaction, all accumulated suspended losses from that activity become fully deductible at once.4Internal Revenue Service. Topic No. 425, Passive Activities – Losses and Credits
How Long the Loss Lasts and How Much You Can Use
The rules split at the end of 2017.
Losses From Tax Years Beginning After December 31, 2017
These NOLs carry forward indefinitely. There is no expiration. But the amount you can deduct in any single year is capped at 80% of taxable income figured before the NOL deduction and certain other adjustments.5Internal Revenue Service. Instructions for Form 172 If taxable income before the NOL is $200,000, you can use up to $160,000 of post-2017 carryforward this year and roll the rest forward. The 80% cap guarantees the government collects at least some tax in your profitable years, even if you have large accumulated losses on the books.
Losses From Tax Years Beginning Before January 1, 2018
Older NOLs originally came with a two-year carryback and a 20-year carryforward window.6Internal Revenue Service. 4.11.11 Net Operating Loss Cases A loss from 2017 — the last year under the old rules — can be carried forward through 2037 before it expires. The advantage: pre-2018 losses are not subject to the 80% cap and can offset 100% of taxable income in the year you apply them.
Ordering When You Have Losses From Multiple Years
You do not get to choose which year’s loss to use first. The IRS requires chronological application — oldest first.5Internal Revenue Service. Instructions for Form 172 In most situations this works in your favor, because the older pre-2018 losses offset 100% of income while newer losses are capped at 80%.
Carrybacks Are Mostly Gone
Carrying a loss back to a prior year for a refund of taxes already paid used to be routine. That option has been eliminated for most taxpayers. The main remaining exception is farming losses, which can still be carried back two years. Farmers seeking a quick refund from a carryback can file Form 1045, which the IRS is required to process within 90 days.7Internal Revenue Service. Instructions for Form 1045 Application for Tentative Refund Everyone else carries losses forward only.
The Excess Business Loss Gate
Before a large business loss even becomes an NOL carryforward, it has to pass through Section 461(l). This provision limits how much business loss a non-corporate taxpayer can deduct in a single year. For 2026, the cap is $256,000 for single filers and $512,000 for joint filers.8Office of the Law Revision Counsel. 26 USC 461 – General Rule for Taxable Year of Deduction The thresholds adjust for inflation each year.
Any business loss above the cap is disallowed for the current year and converted automatically into an NOL carryforward, subject to the 80% limitation in later years. A taxpayer with $800,000 in business losses on a joint return deducts $512,000 this year, and the remaining $288,000 rolls into next year’s NOL balance. The rule applies through at least 2028 after being extended by the Inflation Reduction Act.
How to Claim the Deduction on This Year’s Return
Using a prior-year loss on your current return takes three pieces of information and a few forms.
Know Your Available Balance
You need the original loss amount from the year it occurred, the amount already used in every intervening year, and the remaining balance available now. If you used $40,000 of a $100,000 NOL over the past three years, your available carryforward is $60,000. Double-counting a loss already applied is the kind of error that triggers IRS correspondence.
Where It Goes on the Return
Report the NOL deduction on line 8a of Schedule 1 (Form 1040), which flows into line 8 of Form 1040 as part of your additional income.9Internal Revenue Service. Schedule 1 (Form 1040) – Additional Income and Adjustments to Income Enter it as a negative number, which reduces adjusted gross income. Compute the deduction and apply the 80% limitation using Form 172 and its instructions.5Internal Revenue Service. Instructions for Form 172 IRS Publication 536 walks through the calculation for individuals, estates, and trusts.10Internal Revenue Service. About Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts
Once the return is processed, the IRS updates your tax account transcript to reflect the applied NOL. That transcript becomes the official record of how much of your carryforward has been used.
When the Carryforward Will Not Actually Save You Money
Having an NOL on the books does not guarantee a tax benefit this year. A few situations produce zero savings even though the loss is applied.
- Your income before the NOL is already low enough that taxable income on line 15 of Form 1040 is zero. The NOL simply drives an already non-taxable figure further negative. The unused portion carries forward, but this year it changes nothing.
- The NOL reduces federal income tax, not self-employment tax. Self-employment tax is calculated on current-year net earnings, and a prior-year loss does not factor in. A self-employed taxpayer with $50,000 in current-year earnings and a $50,000 NOL carryforward owes no income tax but still owes roughly $7,065 in self-employment tax.
- Pre-2018 losses expire after 20 years. A loss from 2016 expires after 2036. If your income stays too low to absorb the balance before expiration, that portion is gone permanently.
State Rules Often Do Not Match Federal Rules
Federal NOL treatment does not automatically apply at the state level. Many states set their own carryforward periods, percentage limits, and dollar caps. Some do not allow carrybacks at all, even for farming losses. Others impose a fixed annual cap regardless of the federal 80% rule. If you earn income in more than one state, each state return may need its own NOL schedule. Check state conformity before you file; the differences can materially change what your prior-year loss is worth.