Net Operating Loss (NOL): Carryforward Rules and How to Use Business Losses

Your startup loses $200,000 in year one. Your spouse earns $150,000. You expect to wipe out the tax bill entirely. Instead, the excess business loss limitation caps your current-year deduction, and the rest becomes a net operating loss carryforward. Understanding how NOLs work is critical for any business owner who expects early-year losses to pay off later.

Key Takeaways

• Net operating losses can only be carried forward under current law --- no carrybacks.
• NOL carryforwards are limited to 80% of taxable income in any given year.
• The excess business loss limitation (Section 461(l)) caps current-year business losses before the NOL calculation.
• The TCJA changed the rules significantly: pre-2018 NOLs had different (more generous) treatment.
• All remaining NOL is released when used over time --- carryforwards do not expire.

What Is a Net Operating Loss?

A net operating loss occurs when your allowable tax deductions exceed your taxable income for the year. For individuals, NOLs most commonly arise from:

• Business losses (Schedule C, partnerships, S-corps)
• Rental real estate losses (for real estate professionals)
• Casualty and theft losses
• Farm losses

NOLs do not include personal deductions like the standard deduction, personal exemptions, or capital losses beyond the $3,000 annual limit. Only business-related deductions drive the NOL calculation.

How the 80% Limitation Works

Under current rules, when you carry an NOL forward to a profitable year, you can only offset 80% of that year’s taxable income (computed without the NOL deduction). The other 20% remains taxable.

Worked example: You carry forward a $500,000 NOL. In the current year, your taxable income before the NOL deduction is $300,000.

• Maximum NOL deduction: 80% x $300,000 = $240,000
• Taxable income after NOL: $300,000 - $240,000 = $60,000
• Remaining NOL carryforward: $500,000 - $240,000 = $260,000

That $260,000 carries forward to the next year (and the year after, indefinitely) until fully used. NOL carryforwards under current law do not expire.

Excess Business Loss Limitation (Section 461(l))

Before you even get to the NOL calculation, the excess business loss limitation caps how much net business loss a non-corporate taxpayer can claim in a single year. Losses above the threshold are not lost --- they convert into NOL carryforwards.

The 2025 thresholds are from IRS Rev. Proc. 2024-40. The 2026 figures are estimated based on inflation adjustments and will be confirmed by the IRS.

How it works: If your aggregate net business losses for the year exceed the threshold, the excess is treated as an NOL carryforward to the next tax year. The TCJA originally introduced this rule through 2025, and the Inflation Reduction Act of 2022 extended it through 2028. It is not currently permanent --- check for further legislative changes.

Example: A single taxpayer has $400,000 in business losses and $50,000 in W-2 income. Net business loss = $350,000. The excess over the $305,000 threshold ($45,000) becomes an NOL carryforward. The taxpayer can deduct $305,000 of business losses against income this year.

NOL Rules Before and After TCJA

The Tax Cuts and Jobs Act of 2017 significantly changed NOL treatment. Here is a comparison:

Rule	Pre-TCJA (before 2018)	Post-TCJA (2018+)
Carryback	2 years (general)	None (except farming)
Carryforward	20 years	Indefinite
Income limitation	None (could offset 100%)	80% of taxable income
Excess business loss limit	None	Applies (Section 461(l))

The elimination of carrybacks means you cannot amend prior returns to claim a refund for current-year losses (as was common before 2018). The trade-off is that carryforwards now last forever instead of expiring after 20 years.

Note: NOLs arising in 2018, 2019, and 2020 had special COVID-era rules allowing 5-year carrybacks under the CARES Act. Those provisions have expired.

Capital Loss Carryforward

Capital losses follow different rules than NOLs and are often confused with them:

• Annual deduction limit: Net capital losses are limited to $3,000 per year ($1,500 if married filing separately) against ordinary income.
• Unlimited offset of capital gains: Capital losses first offset capital gains dollar for dollar with no limit. Only the net excess is capped at $3,000.
• Carryforward: Unused capital losses carry forward indefinitely, retaining their character (short-term or long-term).
• No carryback: Like NOLs, capital loss carryforwards cannot be carried back.

For strategies to generate capital losses intentionally, see our tax loss harvesting guide and tax loss harvesting strategy.

How to Claim an NOL

1. Calculate the NOL: Use the NOL worksheet in IRS Publication 536 to compute your net operating loss for the loss year.
2. Determine the carryforward: The NOL carries to the next tax year automatically. Attach a statement to your return showing the NOL computation and carryforward amount.
3. Apply to future returns: On Form 1040, the NOL deduction appears on Line 8 (Other income) as a negative number, or is claimed on the NOL deduction line depending on the year’s form layout. Use Schedule 1 to report.
4. Track your balance: Maintain a running record of NOL generated, NOL applied, and remaining carryforward for each year. The IRS can ask for this documentation.

If you need to amend a return to properly claim an NOL deduction, use Form 1040-X.

Worked Example: Startup Founder With Year-1 Losses

Year 1: Casey launches a software business. Revenue: $40,000. Expenses: $180,000 (development, marketing, equipment). Casey also has $80,000 in W-2 income from a day job.

• Net business loss: $140,000
• Excess business loss check: $140,000 is below the $305,000 threshold (single), so no excess business loss limitation applies.
• Net income: $80,000 W-2 - $140,000 business loss = -$60,000 (before standard deduction).
• NOL for the year: $60,000 (approximately, after adjustments).

Year 2: The business turns profitable. Casey leaves the day job. Business income: $200,000. No other income.

• Taxable income before NOL: $200,000 - $15,000 (standard deduction) = $185,000
• NOL deduction: 80% x $185,000 = $148,000 (but Casey only has $60,000 in NOL)
• Full $60,000 NOL is used. Taxable income: $185,000 - $60,000 = $125,000
• Remaining NOL carryforward: $0

Casey’s year-1 losses reduced year-2 taxes by roughly $14,400 (at the 24% marginal bracket). The NOL carried the startup’s early pain forward into a tangible tax reduction.

For more strategies to maximize small business deductions and ensure your venture qualifies as a business rather than a hobby under IRS rules, see our dedicated guides. And for the broader picture of how self-employed tax strategies and the TCJA sunset could affect your planning, explore those resources as well.

How sharper.tax Helps

sharper.tax identifies business losses on your uploaded return and models how NOL carryforwards can reduce future tax bills. We track the 80% limitation and excess business loss thresholds so you know exactly how much of your loss is usable this year and how much carries forward.

Sources

• IRC Section 172 --- Net Operating Loss Deduction
• IRC Section 461(l) --- Excess Business Loss Limitation
• IRS Publication 536 --- Net Operating Losses for Individuals, Estates, and Trusts
• IRS Form 1045 --- Application for Tentative Refund (includes NOL computation)

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The information above is educational and not tax advice.