Why a $900,000 Depreciation Loss Only Offsets $512,000 This Year
Section 461(l) is the fourth and last limit a business loss has to clear, and the one almost nobody plans for. For 2026 it caps the loss usable against wages at $512,000 on a joint return — $114,000 less than last year.
Cost segregation works. Bonus depreciation works. The seven-day rule and real estate professional status work. A short-term rental owner can do everything right, generate a $900,000 first-year loss, and still find that only $512,000 of it reaches income this year.
The reason is section 461(l), the excess business loss limit. It is the fourth and final hurdle a loss has to clear, it applies after every test people usually plan around, and for 2026 it just got smaller.
1 Four limits, and they run in order
A business loss does not go straight to your return. It passes through four gates, each asking a different question. Clearing one says nothing about the next.
This is why the two conversations get confused. Everything written about the STR loophole is about gate three. Almost nothing is about gate four, which is where a large loss actually gets trimmed.
2 The cap for 2026 is smaller than it was
The threshold is inflation-adjusted, so most years it drifts up. This year it went down, and by a lot.
A plan built on the 2025 figures is roughly 18% too generous for 2026. If someone modeled a 2025 purchase and slid the closing into January, the model needs redoing.
3 Your salary does not raise the ceiling
This is the part that surprises people, and it is the reason the limit bites hardest on exactly the household that planned for it: one spouse with a large W-2, the other running the real estate.
Business losses can offset wages, but only up to the threshold. Wages themselves are not business income, so they do not enlarge the room available. The IRS instructions for Form 461 put it directly: the excess is determined "without regard to any deductions, gross income, or gains attributable to any trade or business of performing services of an employee."
Two consequences follow, and both catch people out:
- Pay from a company you own is still wages. An S corporation salary you set yourself does not count as business income for this test.
- Hours and income are separate questions. An owner-employee's hours can count toward real estate professional status. That does not convert the pay into business income here.
4 What counts as business income, and what does not
The test aggregates every trade or business on the return, not one property at a time. On a joint return that means both spouses combined, and for a partnership or S corporation it is applied to you as the owner rather than at the entity.
Generally not business income for this test: ordinary W-2 wages, including from a corporation you own · portfolio interest and dividends from personal accounts · capital gains on stocks and other non-business assets · pensions, IRA distributions, annuities and taxable Social Security · rental or royalty income that is not a trade or business.
Two mechanics in the computation are worth knowing because they change the arithmetic:
- Capital losses are excluded from the deductions side entirely.
- Capital gains are capped. They count only up to the lesser of capital gain net income limited to gains and losses attributable to a trade or business, or capital gain net income overall.
5 What it looks like on a real return
A married couple filing jointly for 2026. The real estate side has already cleared basis, at-risk and passive activity, so the loss is live. They have $900,000 of business deductions against $100,000 of business income.
Net business loss — $800,000
Less the 2026 joint threshold — ($512,000)
Excess business loss, deferred — $288,000
$512,000 offsets wages and other income this year. The remaining $288,000 does not vanish; it becomes a net operating loss carryforward. Form 461 is where the calculation happens, and the disallowed amount goes back onto the return as a positive number on the other-income line, flagged "ELA".
6 Deferred, not lost — but the timing is the cost
The carryforward is real and it does get used. What changes is when, and how fast.
A post-2017 NOL carryforward is generally limited to 80% of taxable income in the year it is used. So a deduction you underwrote as a single-year event can arrive across several years, and the cash-flow model that justified the purchase may have assumed otherwise.
That is the actual risk here. Not losing the deduction — getting it later than the model said.
7 What to do before a big depreciation year
- Model several years of cash taxes, not one. Before a cost segregation study, a bonus depreciation election or a section 179 claim, run the multi-year picture. A large first-year deduction is not the same thing as a large first-year benefit.
- Time business income where you can. Business income raises the room under the cap. A gain recognized in the same year as the loss makes more of the loss usable.
- Coordinate both spouses. The businesses aggregate across the household on a joint return, so the two sides have to be planned together rather than separately.
- Track the buckets separately. Suspended passive losses, at-risk carryovers and NOL carryforwards follow different rules and are not interchangeable.
- Re-check the threshold each year. It moves, and this year it moved down.
None of this changes whether a building is worth buying. It changes when the tax benefit shows up. The mistake is underwriting an asset on a first-year number and then finding the number arrives over five years.
If you are planning a cost segregation study or a large depreciation year, we model the multi-year cash tax position before the study is commissioned rather than after the return is filed. Our tax solutions team can run your own numbers against the cap.
General information for owner-operators, not tax advice. Thresholds change and state treatment varies; confirm current requirements for your own facts before acting.
Frequently asked
Questions, answered
Does real estate professional status get around the excess business loss limit?
No. Status decides whether a rental loss is passive under section 469, which is the third of four limits. The excess business loss test in section 461(l) is the fourth and applies to the loss afterwards, whether or not you qualify. The two are separate conversations and qualifying for one does nothing for the other.
Do my W-2 wages count as business income for this test?
No. The IRS instructions for Form 461 state the excess is determined without regard to any deductions, gross income, or gains attributable to any trade or business of performing services of an employee. Business losses can offset wages up to the threshold, but wages never raise the threshold — and pay from an S corporation or C corporation you own is treated the same way.
Is the disallowed loss lost?
No. It becomes a net operating loss carryforward. The cost is timing rather than the deduction itself: use of a post-2017 NOL carryforward is generally limited to 80% of taxable income, so a deduction underwritten as a single-year event can arrive over several years.
Is the test applied per property or per entity?
Neither. Every trade or business on the return is aggregated into one figure, and on a joint return that includes both spouses. For partnerships and S corporations the test is applied to you as the owner rather than at the entity level.
What are the thresholds for 2026?
$256,000 for single filers and $512,000 for joint returns, under Rev. Proc. 2025-32 section 4.31. For 2025 they were $313,000 and $626,000, so a joint filer has $114,000 less headroom this year because the One Big Beautiful Bill Act reset the inflation base year.