EP 138 - The Hidden Tax Limit That Stops High Earners From Offsetting W-2 Income

We unpack the Excess Business Loss limitation and show how it caps the amount of business loss you can use against W-2 wages, interest, dividends, and capital gains. We share thresholds for 2025–2026 and walk through timing moves with cost segregation, capital gains, credits, and withholding.

• who EBL hits hardest among high W-2 earners and investors
• section 461 rules that limit losses against non-business income
• 2025 and 2026 thresholds for single and joint filers
• why carryforwards lose value for rental losses
• timing cost segs and electing out of bonus on classes
• pairing staged losses with staged capital gains
• stacking credits and charitable strategies after EBL caps
• using W-4 planning to access tax savings sooner

If any of this is applicable to you and you want to learn more and see how these concepts apply, and also if you want to get a personalized video made from me where I will review your situation and I will outline what may be possible when we use advanced tax reduction strategies and which of these strategies listed above may apply to you and how much it could save you, and anything else to help you understand how advanced tax reduction can apply to your situation. I suggest you go to http://www.prosperalcpa.com/apply. That's prosper with an L CPA.com slash apply.

Transcript

The Hidden Limit On Losses

SPEAKER_00 0:00

If you're a high W 2 income earner and you're trying to use real estate, oil and gas, or other kinds of lost strategies, maybe involving asset depreciation to offset the W-2, there's a hidden limit that stops most people. And almost no one really seems to understand this topic. And it is possible that you could invest a million dollars into a set savings strategy this year and still not reduce your taxes by a single dollar. And that's why I'm gonna dive into this topic on excess business loss limitation. Let's talk about who this applies to. If you are a high-income earning W-2 earner, in this example, I would say it really matters when you're making over$750,000 a year. We see this a lot with our tech employees, especially our tech employee clients in California. Also, any type of real estate investor trying to offset income, oil and gas investors. We also see this with folks who are trying to use loss strategies to offset a significant amount of stock capital gain. And we also consider these factors when we are working with solar strategies and considering oil and gas strategies, or maybe in instances where one spouse has a business operating at a loss and the other spouse has high W-2 income. Now, if you make below uh half a million, this strategy, this concept is likely irrelevant to you. But let me share with you how important this could be. Imagine you have 1.2 million of W-2 income and you do a cost segregation study, let's say on a long-term or short-term rental, and you create an$800,000 loss. Well, if you're married filing joint, you may be thinking that, well, this is wonderful. I can create an$800,000 deduction to save on my taxes. And then when you see the drafted return, you may be unpleasantly surprised to see that that loss is only going to be$626,000. Or in the future, that loss might even be as low as$512,000 based on recent changes in the law. Or if you're a single filer, that could be as low as a quarter million dollars. So this stuff can really impact the effectiveness of your loss strategies and planning and timing. And if you don't understand this and you don't plan for it and factor this in on how you prepare the return and how you time certain events, which we'll dive into, you could be leaving hundreds of thousands of dollars on the table. And here's where elite players think that most normal CPAs don't, on strategic planning around excess business loss limitations. So let's dive into what this thing is excess business loss limitation. And this is an incredibly important topic again for you high W-2 earners and uh also for stock gains. And let's talk about it. Um, there's a tax rule under code 461, and that limits the amount of business losses a taxpayer can use in the current year against non-business income. So this is when we have an individual who is looking to apply a business loss against the non-business income, which may include W 2 income, interest income, dividend income, and capital gain income, etc. etc. All those items where you're not really involved is not really a business investment, it's corporate stock, it's these other forms of income. And obviously the W-2 as I listed earlier, which is usually the most applicable. Now, what we find here is anything above the excess business loss limitation threshold, which we'll dive into, is carried forward. And oftentimes, when we carry a loss forward, the nature of that carry forward and the value can be diminished significantly. So let's talk about what these thresholds are and how much of a loss you can take. If you are single and we are talking about your 2025 return, the maximum loss that you can take against non-business income, those items we've listed earlier, is$313,000. If you're married filing joint in 2025, as you're doing your 25 returns, that amount is$626. Now, here's where it gets really interesting, and a lot of people overlook this. I see tons of people celebrating 100% bonus depreciation is back. This is gonna be fantastic for us in our ability to use the rentals to offset our W-2 incomes. Well, yes, that's true. However, there is an element of the one big beautiful bill that a lot of people overlooked, and they may find that they are gonna get bit in the butt a little bit when they see the results on future returns, and that is a reduction in the excess business loss limitation. So the maximum amount of business losses, and that could be your again, your rental losses or any depreciation strategies, the massive maximum amount that you can take against your W-2 or stock or all those incomes now is actually going to be$256,000 in 2026 and$512,000 if you're married filing joint. So usually when we see these loss thresholds and all these incentives, we they usually grow with inflation. Like you would see that with the standard deduction and other potential thresholds. But this is an instance where you're actually losing a tax incentive and the privilege to use your losses, you're losing over a hundred thousand dollars of that potential loss if you were married filing joint. So this is something to consider. And a lot of you guys probably don't even know what it is and never played it for it before, and it's highly important, especially for those of you in the high-income tax brackets. So, where do we see these losses? Let me just give you a little more context on why this is important. Obviously, we have short-term rental loophole where you're using short-term rentals to offset your W-2s and potential stocks, is most common. We also see this a few handful of clients will have some sort of business that creates bonus depreciation. A popularized one is involving purchasing equipment that you rent out, and the equipment can be written off immediately. They'll oftentimes finance it. So imagine paying$100,000 to acquire a million dollars and then getting a$1 million deduction and only spending$100,000. Oil and gas is applicable. A lot of the times, though, folks don't have enough capital to deploy for the where this is relevant unless you're stacking it. And also, we see this with general business losses and startup expenses, a little less common there. Now, another thing to think about here when we talk about loss netting, if you have a capital loss, a stock loss, you can still offset all of your stock gain. So you can still net those out to zero and you'll be totally fine. But this is where the DIY tax planners really fall apart, the DIY tax planning, because there are crucial elements that they don't consider here. And when you're trying to figure this out on your own and save a couple of bucks on an advisor here. Um, let's talk about what happens when the losses are carried forward. Uh well, when you have a loss that exceeds those thresholds, they are carried forward. So if you have a hundred thousand dollar, if you have a million-dollar loss and you can only take six hundred and twelve, then you can consider the fact that a little over uh a little under$400,000 can be carried forward and used in a later year. And that can offset up to 80% of taxable income in the following year, and that'll carry forward indifferently. So you may think to yourself, so why do I really care so much? I'm gonna use a loss in the following year. So why is this guy, this cat tax key, it's really uh emphasizing the importance of this? Well, it's incredibly important when we consider the fact that you may have rental income, which has the different treatment of the loss carry forwards. So when you carry forward a rental loss that is unused, even if you have real estate professional tax status, even if you have the short-term rental loophole in play with material participation where you should be able to use those losses to offset your W-2s, when they carry forward, the nature of the loss in the carry forward changes. The loss carry forward, when it's carried forward into the later years, will not be able to offset future W-2 income, and that's incredibly important here because let's say back to that example here, you create an eight hundred thousand dollar business loss from your short-term rental business, let's say, and you're only able to use six five hundred and twelve thousand of that amount. Well, we then have a good chunk of losses carrying forward, a little less than three hundred thousand in that example, and you are not gonna be able to see the same benefits, those losses lose their value because they cannot offset your W-2. The rental losses could only offset positive rental profits or rental capital gains. So you can see here that if you have the scenario, you went through all this effort to buy the rental and do the cost seg, and you're so excited about the losses, and some of these losses may not even be from the cost seg, it may be from general expenses and equipment, etc. etc. etc. All other losses from expenses you've created, but you're not even going to really see a ton of value until you start seeing cash flow positive real estate, and that may be years, and that may be never for you because you may have an aggressive purchasing strategy with lots of depreciation. So, not only is it important that we can use our losses to offset the W-2, but this really fits into the whole picture of why we're doing this a lot of times. A lot of times, we will make the facts align so we can use the losses so it reduces our taxes and we get a tax refund or we owe less than taxes, which gives us more liquidity to build and grow and compound our wealth and our portfolios exponentially. Well, the EBL excess business loss may kick in and squash or certainly diminish some of these opportunities. And what I would say is most CPAs don't really plan around this, they just report what they're given. But there are things that you can do retroactively after the year is ended to factor in excess business loss. So I'm recording this in March of 2025. Sorry, March of 2026. As we are doing the 2025 returns, the excess business loss limitation is a factor we are considering with our high W-2s, and you should be considering with yours if you're making over a certain threshold. And the way that we look at this is we especially with cost segregation, we have the opportunity to make critical decisions and elections that will impact the timing of the depreciation. And what we will see here is if we have a loss that is approaching or above that excess business loss limitation, we know we want to do everything we can to avoid it being carried forward. So we have a quarter million dollars in excess of that threshold. We don't want to recognize in the current year because we know when we move it forward, it will not be nearly as valuable. So, how can we potentially move things around and time our depreciation to be most advantageous for the client? And this is again why it's important, even when you're doing the tax return, and some people say, oh, the tax return is admin work. You can you can absolutely and you absolutely need to be strategic as you're doing the tax return and understand the tax planning concepts. And we put tremendous efforts into bridging the gap between the advisors and the preparers to make sure that we're aligned and making the decisions on the tax return because there is room for interpretation and flexibility, and there are opportunities to elect certain items that we're making the right decisions and aligning them properly to set our clients with long-term tax savings. So, some of the things you can do here when you find that you have the opportunity for more losses than you need, you can time the reporting of the cost segregation studies. So let's say you have three rental properties, you have access to way more depreciation than you need. You may decide to only report one or two of those cost eggs, and believe it or not, you can report a final or remaining cost eggs in later year returns. And this is gonna give you the opportunity to avoid losses in excess of that amount. So let's go back to the imagine that you have this an extra quarter million dollar of losses that's gonna carry forward and lose its the nature of the loss. What we can do here is we can say, hey, well, that cost seg over there that generated an extra quarter million of loss, we're not gonna run it. We're gonna actually report it in next year's return because we know the client isn't gonna be doing as many purchases, and he'll be able to use those losses to offset his W 2 income next year. We could let's say we only have one cost segregation study that's giving us more losses than we can, a large property. We can actually elect out of bonus depreciation. We can elect out of bonus depreciation on maybe the five-year life property and just have an accelerated depreciation amount. So we're still writing off a good amount of the property. We're still getting good still getting bonus depreciation on the 15-year life property. So we're still writing off some of these items we've identified in the cost segregation study. We're writing it all off up front, a portion of it, and a portion of it we're gonna spread out and we're gonna prolong the accelerated depreciation, still over a shorter period than we would have normally done it. We're still compressing it into five years, where we're doing it, we're breaking it out over time into smaller pieces so we can see the value of the overall tax savings for the clients. And it's not just about timing of the losses that's important here, there are also gonna be opportunities to time income. So we want to consider this along the lines of if you have a capital gain, so if you have a stock capital gain and it's in it's gonna take you over that excess business loss limitation threshold, maybe we time the recognition of the gains into multiple years so we can use uh as efficiently as possible our non-business, our our business income or losses to offset that. For example, uh, we have access to a million dollars of cost seg losses. We know we can only use 600,000 a year. We want to offset a million of stock gain. Maybe we deploy half a million of the losses in year one, and we recognize the stock gain at half a million in year one, and then we recognize another half a million of losses by reporting another cost seg in the following year. We time the cost seg loss as we discussed earlier, and that's when we recognize the gain on the additional stock. Now, we also want to consider this with other factors to determine the optimal amounts, and we always talk about how tax planning is all about timing. So there's so many moving factors. If you're considering a strategy and you're trying to determine the optimal amount, excess business loss limitation is a factor, the phasing ins and outs of credits is a factor, the changing brackets, maybe qualified business income deduction is a factor. All these things that we're gonna consider in choosing the optimal amount of whatever strategy you are gonna consider. Also consider the fact that if you're creating losses to offset non-business income, consider the fact that why are you buying these assets? If if your motivation for buying these assets or other items to create losses, if you're greatly incentivized because of the tax savings, like how much of your motivation is tax savings versus profit? You may find that you're buying the real estate, and luckily real estate is very flexible because we can time the cost size, but you're looking to do other strategies, whether it's panels or assets or equipment or data centers or software. Uh, are you is the majority of your motivation gonna be for tax savings? If it is, then you're gonna even if there is some profit, maybe you decide to hold off on the purchases into the following years where you will see the benefits of the losses in an overall reduction of your taxes. Now, we also want to consider the fact that we can stack this. So, especially for our high income earners, and we have clients who will make um five to ten million in W-2, especially uh our California clients with with RSUs, where they're making or at least they're showing uh you know millions of dollars of income. However, they are not really receiving all that in the form of cash because of the RSUs. Uh, so we stack it, so we take the losses as far as we can, and then we stack it on top of tax credit strategies and charitable strategies where we can be most resourceful in combining these items to optimize and create additional tax reduction once we've exhausted all the losses we can. And then we also want to consider the possibility of W4 planning. And what I mean by that is we talk about this a lot lately, is timing uh with timing strategies, is think to yourself, why would I want to give the IRS an interest-free loan on the money that's mine? So we account for this in your W-4 form, which is gonna which essentially is going to determine how much taxes is withheld from your paycheck. And when we know, once we know the client well enough and we know how much losses or charitable deductions or tax credits they're gonna take, we reduce the withholdings to account for that so they have access to their tax savings immediately in their bi-weekly year, whenever they get their paychecks, instead of waiting for the outcome of that return, where especially they're deploying a lot of cash and they're really they're banking on that refund to get to replenish their reserves instead of waiting that long and relying on the check from the IRS, we reduce the withholdings immediately so they have that liquidity and can reinvest sooner. Now, the goal isn't just to create massive losses, it's also about creating usable optimized tax reduction. Now, if any of this is applicable to you and you want to learn more and see how these concepts apply, and also if you want to get a personalized video made from me where I will review your situation and I will outline what may be possible when we use advanced tax reduction strategies and which of these strategies listed above may apply to you and how much it could save you, and anything else to help you understand how advanced tax reduction can apply to your situation. I suggest you go to prosperalcpa.com slash apply. That's prosper with an L CPA.com slash apply. So you can fill out a form, meet with the team, and then I'll use that information to send that video to you and share with you what may be possible. All right, I hope that you found this valuable and have a wonderful day.