Buying equipment and accelerating depreciation can create a business loss that reduces tax on your other income, which is why it shows up in so many business tax planning strategies for high earners. Other loss limits apply first, and then the excess business loss rule caps how much of the loss you can use each year. For 2026 that cap went down. How much loss you can create is only half the question. The other half is how much of it you can actually use this year.
The 2026 limit dropped by $114,000 for joint filers
For tax year 2025, the excess business loss threshold was $313,000, or $626,000 on a joint return, per Rev. Proc. 2024-40. For tax year 2026 the IRS set it at $256,000, or $512,000 on a joint return, in Rev. Proc. 2025-32. The threshold normally rises with inflation each year. This time it fell, after the One Big Beautiful Bill Act changed the rule.
The same law made the limit permanent. It had been scheduled to expire, and the 2025 instructions for Form 461 now say the One Big Beautiful Bill Act permanently extended it. If your planning assumed the cap would go away, it will not.
What counts as an excess business loss
An excess business loss is the amount by which the deductions from all of your trades or businesses exceed the income and gains from them, plus the threshold. Business results from across your return are combined, including sole proprietorship income and partnership and S corporation K-1s. It applies to individuals, estates and trusts, not C corporations. Three details from the Form 461 instructions decide most real situations:
- Wages do not count as business income. A large W-2 salary cannot absorb a business loss beyond the threshold, even though it is the income most people want to offset.
- Capital losses are left out of the calculation. Capital gains count only to the extent they come from the business, so gains on investments unrelated to it do not raise the amount you can use.
- The limit comes last. The at-risk rules apply first, then the passive activity loss rules (limits on losses from businesses you do not actively run), and only then the excess business loss limit.
The loss you cannot use is not gone. Federally, the excess business loss becomes part of a net operating loss (NOL), carried forward until it is used up. In a later year, an NOL from 2018 or after can generally offset no more than 80% of that year's taxable income, figured before the NOL and certain other deductions, per the Form 172 instructions. The deduction is delayed rather than lost, it may take more than one year to use, and it may land in a year when your bracket looks different.
A worked example: same loss, two different years
Take an invented Torrance couple filing jointly. One spouse earns $650,000 in wages. The other owns an S corporation that buys equipment and passes through an $800,000 loss on the K-1, after the basis, at-risk and passive rules. They have no other business income.
Here is the federal treatment of that $800,000 loss under each year's threshold:
| Federal treatment of the $800,000 loss | 2025 rules | 2026 rules |
|---|---|---|
| Loss allowed in the current year | $626,000 | $512,000 |
| Excess carried forward as an NOL | $174,000 | $288,000 |
Identical facts, $114,000 less loss used in the current year, simply because of the calendar. And the $288,000 carried forward is subject to the 80% cap whenever it is used.
Size the loss differently and the result changes. Much of a loss like this often comes from bonus depreciation, which the IRS calls the special depreciation allowance. Under Publication 946, the owner of the property can elect not to claim it, which spreads the deduction over the asset's normal life instead. In this example the S corporation makes that election, not the couple, and it covers all property in the chosen class placed in service that year. Revoking it requires IRS consent. Spread-out depreciation and an NOL carryover both push deductions into later years, but they behave differently: depreciation follows its schedule, while the NOL is capped at 80% of taxable income in the year it is used. Which one fits depends on your expected income, so it is a decision to model before the return is filed, not after.
California runs its own number
California applies its own version of this limit. The 2025 Schedule CA (540) instructions say California law generally does not conform to the One Big Beautiful Bill Act, and the state never adopted the federal pause on the limit for 2018 through 2020. For 2025, California's threshold on form FTB 3461 matched the federal one: $313,000, or $626,000 on a joint return.
As of October 8, 2026, the Franchise Tax Board (FTB) had not published its 2026 threshold. Because California did not adopt the change that lowered the federal figure, our team expects the state number to come in above the federal $512,000. Treat that as an expectation until the FTB confirms it. A higher California threshold would allow a larger net business loss before this particular limit applies, but it does not automatically mean a larger deduction. The 2025 FTB 3885 instructions list federal bonus depreciation among the rules California does not follow, so the same equipment purchase can produce a much smaller California loss in the first place.
California also handles the leftover differently. Form FTB 3461 carries a disallowed loss forward as an excess business loss carryover, not an NOL. The same loss can therefore leave you with a federal NOL and a separate California carryover, each tracked on its own schedule. Those balances need to be recorded every year so neither one gets lost.
What to review before year end
The lesson from this year's change is simple. When a plan creates a loss, the question is not only how large the loss can be, but how much of it you can use in the year you create it, federally and in California. The rest is a carryover with its own timing. Modeling both before you buy the equipment or make the election is what turns a large loss into one that actually lowers this year's bill.
Loss planning works best as one of several business tax planning strategies reviewed together during the year, alongside how our engagements run through the year. If you expect a large loss in 2026 and want to know how much of it you can use, Schedule a tax planning consultation and our team will model it with you.
