How the Individual Net Operating Loss Carryforward Is Limited

An NOL is a tax loss computed under special rules; it is not simply any year in which a taxpayer's expenses exceed cash receipts. For CFP planning, the important follow-through is when the loss can offset income in another year and how the deduction limit affects the remaining carryforward.

Carryforward is the general rule

For NOLs arising in tax years after 2020, the general rule is carryforward to later years. Certain farming losses have a statutory two-year carryback exception. The loss year matters, so do not apply one carryback rule to every NOL without checking its source and the tax law applicable to that year.

The 80% limitation applies to post-2017 losses

For a tax year beginning after December 31, 2020, the deduction generally includes pre-2018 NOL carryovers plus the lesser of post-2017 NOLs available or 80% of the relevant taxable-income amount after the statutory adjustments and pre-2018 NOLs. The calculation is not simply 80% of the return's final taxable income; the Form 172 instructions define modified taxable income and the required ordering.

Apply the oldest NOL first

When several NOLs are available, use them in the order incurred, starting with the earliest. If the deduction exceeds modified taxable income for the year, the unused amount may remain as a carryover, subject to the applicable computation. Maintain a year-by-year schedule so each vintage and amount used can be traced.

A simple illustration

Assume a taxpayer has only a post-2017 NOL and, after the required statutory adjustments, the relevant taxable-income base is $100,000. The general 80% ceiling would limit the deduction to $80,000 for that year; the unused eligible NOL may carry forward. This is a teaching illustration, not a substitute for the Form 172 worksheet or a tax return calculation.

Planning and exam distinctions

• Separate individual NOL rules from corporate NOL rules.
• Identify the loss year before deciding whether a carryback is available.
• Distinguish pre-2018 from post-2017 carryovers when applying the limitation.
• Remember that an excess business loss disallowed under section 461 may be treated as an NOL carryover under the applicable rules.
• Use current IRS forms and instructions because later legislation can change tax-year-specific results.

Key takeaway

Track NOLs by year, apply them in oldest-first order, and calculate the deduction under Form 172's modified-income rules. The broad 80% rule is a framework; the actual result depends on the NOL vintage and statutory adjustments.

Work through the older-loss ordering

Assume, for illustration, an individual enters a later year with a $10,000 pre-2018 NOL and an $80,000 post-2017 NOL. If taxable income before NOL deductions is $100,000 and other statutory adjustments are ignored, the older $10,000 loss is applied first. The 80% calculation for the newer loss uses the taxable-income amount remaining after accounting for the pre-2018 carryover: 80% of $90,000 is $72,000. The maximum combined deduction in this simplified example is $82,000, leaving $18,000 before other tax-return items. The unused $8,000 post-2017 loss remains subject to the carryover computation. Actual Form 172 calculations can differ because modified taxable income and other adjustments must be figured under the current instructions.

This example shows why “the NOL deduction is limited to 80%” is incomplete. A pre-2018 carryover is treated separately, and the percentage ceiling applies to the eligible post-2017 portion under a defined income calculation. If there are several NOL vintages, track each separately and use the earliest first. An unused carryover is not automatically lost just because the current year’s ceiling prevents full use; determine the amount carried forward under the form’s rules.

Keep the loss year and loss type visible

The year an NOL arose controls important parts of its later treatment. For a tax year ending after 2020, the individual carryback rule generally permits a two-year carryback only for the farming-loss portion; the rest is carried forward. A farming NOL carried back is applied to the earliest eligible year first. If the taxpayer waives the carryback when permitted, the choice generally must be made with a timely filed original return and is generally irrevocable. These timing rules make the original return and election record important parts of the carryforward schedule.

Do not treat every business loss as an NOL in the same amount. At-risk and passive-activity rules are applied before the excess-business-loss limitation. A disallowed excess business loss may be treated as an NOL carryforward under the applicable rules, but its amount and later use require the relevant worksheets. The NOL itself also has adjustments when it is computed; for example, certain capital losses and nonbusiness deductions are subject to special limits. Form 172 organizes the computation for individuals, estates, and trusts.

Build a carryforward schedule

For each loss year, record the original NOL, any amount carried back, the remaining amount entering each later year, the part deducted, and the balance carried forward. Then calculate the year’s available deduction with the current Form 172 instructions and retain the supporting worksheet. A running schedule prevents older and newer losses from being combined prematurely and makes it easier to see when the 80% restriction limits use. For planning, model the likely timing of deductions, but distinguish a tax projection from the amount allowed on an actual return.

Use a consistent analysis sequence

For an exam scenario, first confirm that the taxpayer has an NOL calculated under the individual rules. Next identify the loss year and whether any farming portion qualifies for a carryback. Separate pre-2018 and post-2017 carryovers, apply available losses in oldest-first order, and compute the current-year limitation using modified taxable income rather than an unadjusted figure from the return. Finally, calculate the unused amount that moves to the next year. Keeping these steps in order avoids common errors such as applying the 80% limit to older losses or treating the entire business loss as immediately deductible. Because the rules depend on tax year and loss type, read each date and exception in the question before selecting the general carryforward rule.