Excess Loss Limitations – Federal and State Considerations

As Seen in Anchin’s Real Estate Year-End Tax Planning Guide

Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), individual and trust taxpayers that qualified as real estate professionals were able to deduct all their real estate business losses against their other sources of income. If the business losses exceeded the other sources of income, a net operating loss would be created. This loss could either be carried back to offset income from prior years or carried forward to future tax years at the election of the taxpayer.

The TCJA limited the deductibility of business losses for individual and trust taxpayers. For the 2023 tax year, trade or business losses are limited to $578,000 for married couples ($289,000 for single taxpayers). Any “excess business loss” that is not deductible in the current year is carried forward as a net operating loss which can be used to offset income from a future tax period.

This excess business loss provision was initially scheduled to sunset December 31, 2025. However, the Inflation Protection Act of 2022 extended the excess business loss limitation through 2028.

For taxpayers involved in the trade or business of real estate, accelerated depreciation can create substantial taxable losses. Certain qualifying property is eligible for 80% bonus depreciation in 2023 (60% in 2024) in the year it is first placed in service by the taxpayer. However, many states do not conform to bonus depreciation. In determining tax liabilities, many states start with Federal taxable income and adjust for state provisions that “decouple” from Federal tax treatment.

As a result, many states have modifications adding back accelerated deprecation to Federal taxable income. This could lead to adverse tax consequences since the losses from depreciation may have already been limited on their Federal returns. Taxpayers should consult with their advisors to plan accordingly and avoid any surprises when filing their returns.