Can a Net Operating Loss Offset a Capital Gain?

A net operating loss, or NOL, occurs when a business’s tax-deductible expenses are greater than its revenues for a tax year. A capital gain is the profit realized from the sale of a capital asset, such as stocks, bonds, or real estate. An NOL can be used to offset various forms of income, including capital gains. The process is not a direct cancellation of one against the other. Instead, the NOL deduction works by lowering a taxpayer’s overall income, which in turn reduces the total tax liability.

The Offset Mechanism Explained

A net operating loss does not directly cancel out a capital gain in a one-to-one transaction, as the tax system does not pair specific losses with specific gains. Instead, an NOL deduction reduces a taxpayer’s total income base. For an individual, this means lowering Adjusted Gross Income (AGI), while for a corporation, it reduces its overall taxable income.

All forms of income, including wages, business profits, and capital gains reported on Schedule D, are first aggregated to determine gross income. The NOL deduction is then applied to this combined total. Because capital gains are part of this income pool, the NOL deduction effectively reduces them along with all other income. The result is a lower tax bill, achieving the goal of using the business loss to offset the investment profit.

Calculating Your Usable NOL Deduction

Before an NOL can be used to offset income, its usable amount for the year must be calculated. For noncorporate taxpayers, a first step is the “excess business loss” limitation, which caps the amount of net business losses you can deduct in a single year. For 2025, this limit is $326,000 for single filers and $652,000 for joint filers. Any business loss above this threshold is disallowed for the current year and is treated as an NOL carryforward.

Once the NOL amount is determined, its application is governed by rules from the Tax Cuts and Jobs Act (TCJA). NOLs arising in tax years after December 31, 2017, cannot be carried back and must be carried forward indefinitely. An exception exists for farming losses, which retain a two-year carryback period. The deduction for an NOL that arose after 2017 is limited to 80% of the taxable income for that year, calculated before the NOL deduction is taken. This means a taxpayer cannot use these NOLs to completely eliminate their taxable income.

NOLs generated in tax years before January 1, 2018, are not subject to this 80% cap and can offset 100% of taxable income. If a taxpayer has carryforwards from both pre-2018 and post-2017 years, the pre-2018 losses are applied first. Then, the post-2017 losses are used, subject to the 80% rule against any remaining income.

To illustrate, consider a taxpayer with $200,000 in taxable income, which includes a $50,000 capital gain, and a $300,000 NOL carryforward from a post-2017 tax year. The maximum usable NOL deduction is 80% of taxable income, or $160,000 ($200,000 x 80%). The taxpayer can deduct $160,000, reducing their taxable income to $40,000. The remaining $140,000 of the NOL is carried forward to future years, subject to the same 80% limitation.

Application for Individual and Corporate Taxpayers

The procedure for applying a calculated NOL deduction differs between individuals and corporations. For individual taxpayers, the process involves reporting the deduction on Schedule 1 of Form 1040, which is used for “Additional Income and Adjustments to Income.” The usable NOL amount is entered as a negative number on the “Other income” line. This entry directly reduces the taxpayer’s total income, contributing to the calculation of Adjusted Gross Income (AGI).

For C corporations, the application is more direct. Unlike individuals who have different tax rates for ordinary income and long-term capital gains, corporations are taxed at a flat rate on all their income. Capital gains are pooled with operating income, and the NOL deduction is taken directly on Form 1120, the U.S. Corporation Income Tax Return. This deduction reduces the corporation’s total taxable income before the corporate tax rate is applied.

While the forms and calculation flow differ, the result is the same for both individuals and corporations. The business loss is used to decrease total taxable income, which includes any capital gains, thereby lowering the final tax owed.

Ordering Rules in the Tax Calculation

The sequence in which deductions are taken is a regulated part of preparing a tax return, particularly for individuals. The placement of the NOL deduction in this sequence has consequences for other parts of the tax calculation. The NOL deduction is applied at a specific point to correctly determine Adjusted Gross Income (AGI).

This placement is important because AGI serves as a benchmark for determining eligibility and limitations for numerous other tax benefits. An interaction is with the Qualified Business Income (QBI) deduction, available to owners of pass-through entities. The QBI deduction is based on taxable income computed after the NOL deduction has been applied, so a large NOL can reduce the amount of the QBI deduction.

The NOL deduction is also taken before standard or itemized deductions. By lowering AGI, the NOL can indirectly affect the calculation of certain itemized deductions that are subject to AGI-based limitations. This established order ensures that income is reduced systematically on the tax return.