Taxorly AI Tax Advisor
Answered May 14, 2026
Yes, you can potentially deduct business losses against other income, but it's nuanced. Here’s a breakdown:
* **Hobby Loss Rule:** The IRS first determines if your activity is a business or a hobby. To be a business, you must operate with a *profit motive*. If it’s a hobby, deductions are limited to income generated from the hobby – you *cannot* deduct a loss.
* **At-Risk Rules:** You can only deduct losses *up to* your investment (“at-risk” amount) in the business. For example, if you invested $5,000, losses are limited to $5,000.
* **Passive Activity Loss (PAL) Rules:** These are the biggest hurdles.
* **Material Participation:** If you *materially participate* in your business (regular, continuous, and substantial involvement), losses are generally *not* limited. Examples: actively managing a consulting business, regularly performing services as a freelancer.
* **Non-Material Participation:** If you *don't* materially participate (e.g., a silent partner in a rental property), your losses are considered passive and can *only* offset passive income.
* **Net Operating Loss (NOL):** If your business losses exceed your income and applicable limits, you may have a Net Operating Loss.
* **2018-2020:** NOLs could be carried back 5 years & forward 20.
* **2021 onward:** NOLs can *only* be carried forward indefinitely, and are limited to 80% of taxable income in the carryforward year.
* **Example:** Sarah is a freelance graphic designer. She spent $10,000 on equipment and only earned $6,000 in revenue. She *materially participates* in her business. Assuming she’s at-risk for the full $10,000, she can deduct a $4,000 loss against her employment income.
⚠️ Disclaimer: This is for educational purposes only. Always consult a licensed CPA for personalized advice.