Cost Segregation & the 2026 Excess Business Loss Rule
The One Big Beautiful Bill Just Restored 100% Bonus Depreciation. Here's the Catch Nobody's Talking About.
By Kamila Lily Kowalska, Cost Segregation Specialist
After The One Big Beautiful Bill was signed into law, and my phone has been ringing ever since.
Commercial real estate investors were excited, and they should be. The bill restored 100% bonus depreciation for qualifying property, which means cost segregation studies just became significantly more powerful. Properties you acquire or place in service in 2026 can now generate a full first-year deduction on reclassified components instead of the phased-down percentages we've had for the past few years.
That's genuinely good news.
But there's a rule that was already in place before the bill passed, one that the celebration is drowning out, and for high-income investors, it can quietly cut that deduction in half.
It's called Section 461(l), the Excess Business Loss limitation. And in 2026, its threshold just dropped to the lowest level in years.
If you're counting on a cost segregation study to shield your income this year, this article is worth three minutes before you call your CPA.
Two Things Happened at Once, and They Work Against Each Other
The One Big Beautiful Bill restored 100% bonus depreciation. That's the headline investors are reading.
What's not in that headline: the 2026 excess business loss thresholds also changed, in the opposite direction.
The IRS sets a cap on how much net business loss a non-corporate taxpayer can actually use in a single year. In 2025, that cap was $313,000 for single filers and $626,000 for joint filers.
In 2026, those numbers dropped significantly.
The 2026 thresholds are now $256,000 for single filers and $512,000 for joint filers (per Rev. Proc. 2025-32). That's a drop of nearly $60,000 for individuals and over $114,000 for married couples filing jointly.
So the new law hands you a bigger deduction, and the existing cap limits how much of it you can actually use this year. Any excess above those thresholds becomes a net operating loss (NOL) carryforward, usable in a future year, subject to additional rules and limitations.
For investors who expected a large first-year deduction to wipe out W-2 income, capital gains, or portfolio income this year, that combination can be the difference between a six-figure tax bill reduction and a carryforward that doesn't pay the Q4 estimated tax payment.
Why Cost Segregation Investors Feel This Most
Cost segregation is one of the most powerful tools in the real estate investor's toolkit. By reclassifying components of a building, flooring, lighting, land improvements, specialty systems, from long-life categories (27.5 or 39 years) into 5-, 7-, and 15-year property, investors can dramatically accelerate depreciation into year one.
With 100% bonus depreciation now fully restored, the first-year deduction on a well-structured study can be substantial. That's exactly the point, and exactly why Section 461(l) becomes more relevant, not less.
But here's what the 2026 environment creates: the bigger the acceleration, the more likely you are to bump into the Section 461(l) ceiling, especially if your non-business income (wages, dividends, capital gains) is high.
The rule doesn't care how powerful your cost segregation study is. It applies after every other limitation, basis, at-risk rules, passive activity, and it caps what's left.
The Order of the Gates (Most People Only See the First One)
This is the part that surprises investors the most. The tax code doesn't test your real estate losses with a single rule. It runs them through a sequence:
- Basis limitations - Can you even claim the loss at the partnership or S-corp level?
- At-risk rules - Are you economically exposed for that amount?
- Passive activity rules (Section 469) - Is the loss active or passive? This is where Real Estate Professional Status (REPS) matters.
- Section 461(l) - After all of that, is the remaining net business loss above the annual threshold?
Most conversations about cost segregation focus heavily on step 3, whether you qualify as a real estate professional and can make the loss non-passive. That's important. But clearing the passive activity gate doesn't mean you've cleared all the gates.
A loss that is fully non-passive under REPS can still be partially deferred by Section 461(l) if your aggregate business losses exceed $512,000 on a joint return.
Real Numbers: What This Looks Like in Practice
Let's say a married couple has:
- $900,000 in W-2 wages and investment income
- A cost segregation study on a commercial property that generates $900,000 in year-one depreciation
- After basis, at-risk, and passive activity analysis, the full $900,000 is non-passive and deductible
Here's where Section 461(l) steps in.
If there's no offsetting business income from the real estate activities, the excess business loss is $900,000. The 2026 joint-filer threshold is $512,000. That means only $512,000 is deductible in 2026. The remaining $388,000 becomes an NOL carryforward.
The couple expected the entire loss to shield their high-bracket income this year. Instead, their tax savings are significantly smaller in 2026, and the rest gets pushed into future years — where it may or may not offset the income types they need.
Real Estate Professional Status Helps, But It Doesn't Solve Everything
REPS is still valuable. If a taxpayer qualifies and materially participates in their rental activities, the losses move out of passive status and into the Section 461(l) calculation. That's the right first step.
But I've spoken with investors who treated REPS as the finish line. It isn't. Once the loss is non-passive, Section 461(l) tests whether the aggregate exceeds the threshold. If it does, the deduction is deferred regardless of professional status.
The planning conversation needs to include both.
What Good Planning Looks Like Before Year-End
The good news: Section 461(l) is a planning problem, not a permanent loss of value. The deduction usually carries forward. But "usually eventually useful" is very different from "offsets this year's tax bill."
If you're considering a cost segregation study in 2026, or you've already completed one, the questions worth asking before December 31 are:
How much business income do I have to absorb the loss? Section 461(l) tests net business loss, meaning business income on the same return can raise the effective ceiling. Recognizing business income in 2026 can increase how much loss you use currently.
What is the placed-in-service timing? Accelerating a deduction into a year when you'll hit the Section 461(l) cap may be less valuable than you expect. Sometimes deferring into a better income year is the smarter move.
Does my carryforward actually get used? An NOL carryforward is only worth something if future income materializes to absorb it. If you're planning a sale, refinance, or retirement, the modeling matters.
What does my state do? Many states don't conform to federal excess business loss rules. The federal carryforward may not give you a state deduction at all, or vice versa. This varies significantly.
The Question I Ask Every New Client
Before I ever start talking about cost segregation, I ask: What does your income look like this year, and what do you actually need the deduction to do?
The answer shapes everything, the timing of the study, the depth of the analysis, whether bonus depreciation is the right election, and how the loss fits into a multi-year tax plan.
A cost segregation study that produces a $600,000 deduction sounds like a win. And it can be. But if $344,000 of it goes into a carryforward when you needed the cash savings this year, the conversation should have started earlier.
Section 461(l) isn't a reason to avoid cost segregation. It's a reason to plan around it, and to work with someone who understands where the gates are, and in what order they open.
Most Popular Reply
Agreed @Aaron Zimmerman. I liked when @Kamila Kowalska stated "Before I ever start talking about cost segregation, I ask: What does your income look like this year, and what do you actually need the deduction to do?"
A lot of clients still need to be reminded that the US tax system is a progressive tax system. Taxable income reduction is worth more in the higher brackets than it is in the lower brackets. Sure, we'll welcome an NOL, but I try to explain that the taxable income reduction in the lower brackets isn't worth as much.