The Excess Business Loss Limitation in 2026: Why the Threshold Dropped to $256,000

TL;DR: The excess business loss limitation under Section 461(l) caps how much net business loss a noncorporate taxpayer can use against non-business income in a single year. For 2026 that cap is $256,000, or $512,000 on a joint return. That is lower than the 2025 cap of $313,000 and $626,000, and the drop is not a rounding error. The One Big Beautiful Bill Act moved the inflation base year from 2017 to 2024, which restarted the escalator near the statutory $250,000 floor, and it made the limitation permanent. If you are a high W-2 earner counting on a cost segregation study to erase this year's income, this is the gate that decides how much of it actually clears.

Key Takeaways

• The 2026 excess business loss threshold is $256,000 ($512,000 joint), per Rev. Proc. 2025-32, Section 4.31.
• The 2025 threshold was $313,000 ($626,000 joint), per the Instructions for Form 461 (2025), citing Rev. Proc. 2024-40, Sec. 2.32.
• W-2 wages do not count as business income in this calculation, which is exactly why high earners with rental losses get caught by it.
• The limitation is now permanent. The IRS states it plainly: the OBBBA "permanently extended the disallowance of a deduction for excess business losses."
• Disallowed loss is not forfeited. It becomes a net operating loss carryforward, but the NOL deduction is then capped at 80% of taxable income in the later year.
• This is the last gate, applied after the at-risk rules and after the passive activity loss rules.

What is the excess business loss limitation?

Section 461(l) of the tax code limits how much loss from your trades or businesses you can deduct in a single year if you are not a corporation. The IRS puts it in one sentence in the Instructions for Form 461: "Code section 461(l) limits the amount of losses from the trades or businesses of noncorporate taxpayers that the taxpayers can claim each year."

The arithmetic is straightforward. Add up your business deductions for the year. Add up your business gross income and gains. If the deductions exceed the income by more than the threshold amount, the piece above the threshold is an "excess business loss," and it is disallowed for that year.

The statute sets the base threshold at "$250,000 (200 percent of such amount in the case of a joint return)" and then adjusts it for inflation. Everything after that is indexing.

One detail in the statute does most of the damage, and almost nobody mentions it. Section 461(l)(3)(A) closes with this: the excess "shall be determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee." Your W-2 wages are not business income for this purpose. So a surgeon earning $900,000 on a W-2 gets no help from that $900,000 when the formula runs. The threshold is the only thing standing between her rental loss and her paycheck, and it is a small number relative to what a cost segregation study on a large property produces.

Why did the 2026 threshold drop to $256,000?

Because Congress restarted the clock on the inflation adjustment.

Before the One Big Beautiful Bill Act, Section 461(l)(3)(C) indexed the $250,000 base for tax years beginning after December 31, 2018, running the cost-of-living calculation off a 2017 base year. Eight years of accumulated indexing is how $250,000 became $313,000 by 2025.

OBBBA Section 70601(b) rewrote two numbers in that paragraph. It substituted "December 31, 2025" for "December 31, 2018," and it substituted "2024" for "2017." The provision now reads: "In the case of any taxable year beginning after December 31, 2025, the $250,000 amount in subparagraph (A)(ii)(II) shall be increased" by the cost-of-living adjustment "determined by substituting '2024' for '2016.'" Those amendments apply to taxable years beginning after December 31, 2025, per Section 70601(c)(2) of the Act.

Move the base year forward from 2017 to 2024 and you erase the indexing that accumulated in between. The escalator starts over near the statutory floor. That is how the threshold lands at $256,000 for 2026, which Rev. Proc. 2025-32 states directly: "For taxable years beginning in 2026, in determining a taxpayer's excess business loss, the amount under 461(l)(3)(A)(ii)(II) is $256,000 ($512,000 for joint returns)."

One caveat on where that explanation comes from. The revenue procedure publishes the 2026 figure as a routine inflation-adjusted item. It offers no comparison to 2025 and no commentary on the decrease. The reasoning above is mine, read off the amended statute and the effective date provision in the Act, not an IRS explanation of why the number moved.

The same section of the Act made the limitation permanent. Section 70601(a) struck the expiration language out of Section 461(l)(1), effective for tax years beginning after December 31, 2026. The IRS summarizes it in the "What's New" section of the Form 461 instructions: the OBBBA "permanently extended the disallowance of a deduction for excess business losses." Planning around a sunset is no longer an option, because there is no sunset.

Where does this hit a cost segregation study?

At the very end, after you have already won every earlier argument.

The Form 461 instructions lay out the sequence: "First, apply the at-risk rules; next, apply the passive activity loss rules; and then apply the excess business loss rules." Section 461(l) is the last gate. You can be fully at risk. You can clear real estate professional status so the loss is non-passive, or run a short-term rental where the passive rules work differently. Do all of that correctly and Section 461(l) still gets the final word on how much loss reaches your other income this year.

Here is what that looks like with numbers. Take a married couple filing jointly with $900,000 of W-2 income. They buy a $4 million short-term rental, materially participate, and commission an engineering-based cost segregation study that accelerates roughly $1.1 million into year one. The property throws off $200,000 of gross rents against $1.3 million of total deductions, so the net business loss is $1.1 million.

The W-2 income does nothing in the formula. Business deductions of $1.3 million exceed business gross income of $200,000 plus the $512,000 threshold by $588,000. That $588,000 is an excess business loss and it is disallowed this year. They deduct $512,000 against the W-2 income instead of $1.1 million.

Those figures are an illustration, not a projection. Your basis, your placed-in-service date, your entity structure, and your other business income all move the answer.

Two more wrinkles matter here. Capital losses from sales or exchanges are excluded from the deduction side of the calculation entirely, and capital gains that you might hope would soak up a loss are capped at the lesser of your business capital gain net income or your total capital gain net income, under Section 461(l)(3)(B). And for a partnership or S corporation, Section 461(l)(4) applies the limitation at the partner or shareholder level, though the Form 461 instructions note that "the trade or business determination is made at that entity's level."

Is the money gone, or just delayed?

Delayed. This is a timing problem, and telling the two apart is the whole point of doing the math before you buy.

Section 461(l)(2) says any loss disallowed under the limitation "shall be treated as a net operating loss for the taxable year for purposes of determining any net operating loss carryover under section 172(b) for subsequent taxable years." The $588,000 in the example above rolls forward. It is not lost.

But it comes back slower than it went in. Under Section 172(a)(2)(B)(ii), a net operating loss arising in a tax year beginning after December 31, 2017 can offset no more than "80 percent" of taxable income in the year you use it, computed without regard to the deductions under sections 172, 199A, and 250. So the carryforward cannot wipe out a future year completely either. It chips away at 80 cents on the dollar until it is used up.

For most investors that is still a good outcome. The deduction is real, the study still pays, and the present value of a deduction pushed one or two years out is lower but rarely low enough to change the decision. Where it does change the decision is when someone bought the property specifically to erase one enormous income year, a business sale or a large bonus, and assumed the entire loss would land in that year. It will not. That is the conversation worth having before the closing, not in March.

Who actually has to file Form 461?

The 2025 instructions set two triggers. You file if you are a noncorporate taxpayer and "either (i) your net losses from all of your trades or businesses are more than $313,000 ($626,000 for taxpayers filing a joint return), or (ii) you would report a loss of more than $156,500 on any one of Form 461, lines 1 through 8."

That second trigger catches people who do not think of themselves as having a problem. A single line item over the half-threshold pulls the form into your return even if your overall position is fine.

Those dollar figures are the 2025 amounts, from the Instructions for Form 461 (2025), last reviewed by the IRS on April 30, 2026. The 2026 instructions will carry the $256,000 and $512,000 thresholds. The second trigger, the single-line figure, has tracked at half the single-filer threshold: $156,500 is exactly half of $313,000. On that pattern the 2026 figure would be $128,000. I have not seen it confirmed in a 2026 instruction release, so treat it as an expectation rather than a verified number and check the current instructions before you rely on it.

When the limitation applies, the excess business loss goes on your return as a positive number on the "Other income" line with "ELA" written on the dotted line, which for a Form 1040 filer means Schedule 1, line 8p. Keep the record. The instructions are explicit that you need it: "You'll need to keep a record of your excess business loss from each tax year because it's treated as an NOL carryover for subsequent taxable years."

State treatment is a separate question and worth asking your CPA directly, because states do not uniformly follow the federal rule here.

What should change in your planning?

Model the loss against the threshold before you buy, not after. That is the entire lesson.

A cost segregation study tells you how much depreciation you can accelerate. It does not tell you how much of that depreciation you can use this year. Those are different questions, and the second one depends on your W-2 income, your other business income, your filing status, and now a threshold that got smaller. Any engineering-based study worth paying for should come with a conversation about the second question. If nobody has raised Section 461(l) with you, that is a gap in the analysis.

The rest of the mechanics are unchanged, and the strategy still works. Cost segregation reclassifies building components into shorter recovery periods so depreciation lands sooner, and the full mechanics are here. The 100% bonus depreciation restoration under the OBBBA makes the first-year number larger than it has been in years, which is covered in what changed a year after the bill passed. Section 461(l) simply decides how fast you get to spend it.

My father was a CPA, and he told me tax evasion is a crime but tax avoidance is mandatory. Section 461(l) is Congress writing a rule about timing, not about whether you deserve the deduction. You take the deduction. You just take it on the schedule the statute allows, and you plan around that schedule instead of being surprised by it.

Frequently Asked Questions

What is the excess business loss threshold for 2026?

For taxable years beginning in 2026, the threshold is $256,000, or $512,000 for taxpayers filing a joint return. This comes from Rev. Proc. 2025-32, Section 4.31.

Why is the 2026 threshold lower than the 2025 threshold?

The One Big Beautiful Bill Act, Section 70601(b), moved the inflation adjustment base year in Section 461(l)(3)(C) from 2017 to 2024 and restarted the adjustment for tax years beginning after December 31, 2025. That erased the indexing accumulated between 2018 and 2025, so the threshold reset near the statutory $250,000 base. The 2025 threshold was $313,000, or $626,000 for joint filers.

Do W-2 wages count as business income for the excess business loss calculation?

No. Section 461(l)(3)(A) states that the excess is determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services as an employee. That is why high W-2 earners with large rental losses are the taxpayers most often limited by this rule.

Is a disallowed excess business loss lost permanently?

No. Section 461(l)(2) treats the disallowed loss as a net operating loss for purposes of the carryover rules under Section 172(b). However, under Section 172(a)(2)(B)(ii), the net operating loss deduction in a later year is limited to 80 percent of taxable income computed without regard to the deductions under sections 172, 199A, and 250.

Does the excess business loss limitation expire?

No. The IRS states in the Instructions for Form 461 that the One Big Beautiful Bill Act permanently extended the disallowance of a deduction for excess business losses. Section 70601(a) of the Act struck the expiration language, effective for taxable years beginning after December 31, 2026.

Where does the excess business loss limitation fall in the ordering rules?

It is last. The Instructions for Form 461 direct taxpayers to first apply the at-risk rules, next apply the passive activity loss rules, and then apply the excess business loss rules.

Does the limitation apply at the partnership level or the partner level?

At the partner or shareholder level, under Section 461(l)(4). The Instructions for Form 461 note that the trade or business determination itself is made at the entity level.

Run the numbers before you buy

If you are weighing a property and counting on the depreciation to offset a specific income year, the threshold is worth checking against your actual facts first. I offer a no-cost analysis delivered through my relationship with CSSI (Cost Segregation Services, Inc.). No obligation and no pitch, and if a study will not pay for itself on your building, I will tell you that.

Book a time at calendly.com/david-wiener/cs, or call 770-224-8504 and choose option two. Bring the address and roughly what you paid. Nothing else to gather beforehand.

Sources

• 26 U.S.C. Section 461(l), including subsection (l)(3)(C) as amended by Pub. L. 119-21, title VII, Section 70601, July 4, 2025, 139 Stat. 283, 284.
• 26 U.S.C. Section 172(a)(2)(B)(ii).
• IRS Rev. Proc. 2025-32, Section 4.31 (2026 threshold amounts).
• IRS Instructions for Form 461 (2025), page last reviewed or updated April 30, 2026 (2025 threshold amounts, filing triggers, ordering rules, reporting, and the OBBBA permanence statement), citing Rev. Proc. 2024-40, Sec. 2.32 for the 2025 figures.

This article is educational and is not tax advice. Your facts determine your result, and a limitation this mechanical is worth reviewing with your own CPA or tax advisor before you act on it.