A cost segregation study can move a large share of a building into shorter-life property. With 100% bonus depreciation back for qualifying property acquired after January 19, 2025, that often means a big first-year loss. Real estate professional status is what lets a rental loss offset wages and other nonpassive income on the federal return. Even then, section 461(l) caps how much net business loss a noncorporate taxpayer can use in one year. For tax years beginning in 2026, that cap is $256,000 ($512,000 on a joint return) under Rev. Proc. 2025-32. The excess is not lost. It carries forward as a net operating loss.
A nonpassive REPS loss does not reduce net investment income for the 3.8% tax. See REPS and the NIIT.
This page walks the order of the rules, the 2026 numbers, and what California does differently. For REPS basics, see REPS and passive losses. For bonus depreciation itself, see 100% bonus depreciation under OBBBA.
The stack, in order
Think of the loss as moving through gates. Each gate can stop part of it.
- Basis and at-risk. You cannot deduct more than you have at stake in the activity.
- Passive activity loss rules (section 469). Rental real estate is presumptively passive. REPS removes that automatic passive label for the year you qualify. You still need material participation in the rental activity (or in the grouped activity if you filed the §1.469-9(g) election).
- Excess business loss (section 461(l)). After the passive rules, a noncorporate taxpayer's aggregate business deductions cannot exceed aggregate business income plus the annual threshold. The excess is disallowed for the year and treated as an NOL carryforward.
- State rules. California has its own passive-loss and conformity picture. Federal REPS does not carry over to California.
Skipping REPS and jumping straight to a cost seg study is a common mistake. A large depreciation deduction that stays passive only offsets passive income.
What REPS has to do with cost segregation
Cost segregation does not create REPS. It creates depreciation timing. REPS is about your hours and material participation.
To use a cost-segregation-driven rental loss against W-2 wages or other nonpassive income, you generally need all of the following in the same year:
- One spouse (on a joint return) passes both REPS tests: more than half of that person's trade-or-business hours in real property trades or businesses, and more than 750 hours in those businesses (section 469(c)(7)(B))
- Material participation in the rental activity, under any one of the seven tests in Temp. Reg. §1.469-5T(a)
- Enough basis and at-risk amount
- Room under the section 461(l) cap
If you have several properties and your hours are spread thin, the grouping election is often what makes material participation reachable. Without it, each rental is tested alone.
Hours only help if you can prove them. See what counts toward REPS hours and how to keep a REPS time log.
100% bonus depreciation, briefly
Under the 2025 tax law (OBBBA) and IRS Notice 2026-11, qualifying property acquired and placed in service after January 19, 2025, is generally eligible for a 100% additional first-year depreciation deduction under section 168(k). Cost segregation identifies components (flooring, certain fixtures, land improvements, and similar shorter-life property) that can take that bonus in the year placed in service.
Bonus depreciation is claimed on Form 4562. It does not bypass section 469 or section 461(l). California also does not fully conform to federal bonus depreciation, so a federal first-year deduction can create a California adjustment. See our page on California bonus depreciation nonconformity.
The 2026 excess business loss numbers
Section 461(l) limits excess business losses of noncorporate taxpayers. An excess business loss is the amount by which total deductions from your trades or businesses exceed your total gross income and gains from those trades or businesses, plus the threshold amount. Deductions, income, and gains from the trade or business of being an employee are left out of the computation (so W-2 wages do not inflate the room under the cap).
For taxable years beginning in 2026, Rev. Proc. 2025-32 §4.31 sets the threshold at:
| Filing status | 2026 threshold |
|---|---|
| Single (and other non-joint) | $256,000 |
| Married filing jointly | $512,000 |
For comparison, the 2025 Form 461 instructions used $313,000 / $626,000. The 2026 figures are lower because OBBBA made the limitation permanent and reset the inflation base.
You figure the limitation on Form 461 after applying basis, at-risk, and passive activity loss rules. The disallowed excess is treated as a net operating loss carryover to later years under section 461(l)(2). An NOL carried into a later year is subject to the usual NOL rules, including the 80% of taxable income limitation that applies to post-2017 NOLs in many cases.
A large rental loss can also carry forward as negative QBI. See the QBI rental safe harbor vs REPS.
A plain-numbers illustration
These figures are an illustration, not a client result.
Assume you file jointly in 2026, you qualify for REPS, you materially participate, and a cost segregation study plus 100% bonus produces a $700,000 net loss from your rental activity after other rental income.
| Step | Amount |
|---|---|
| Net rental loss after REPS / material participation | $700,000 |
| 2026 joint §461(l) threshold | $512,000 |
| Deductible against other income this year (before other limits) | $512,000 |
| Carried forward as NOL | $188,000 |
If the same loss were still passive, none of it would offset W-2 wages. REPS gets you to the gate. Section 461(l) decides how much passes through in one year.
When the cap bites hardest
- You stacked cost segregation on more than one property in the same year
- 100% bonus front-loads depreciation that used to spread over five, seven, or fifteen years
- You also have losses from other trades or businesses that share the same taxpayer-level cap
- You expected wages to "cover" a loss larger than the threshold (wages are not business income for the §461(l) math)
Planning levers are timing and sequencing, not inventing a higher cap. Examples include staggering placed-in-service dates across years, modeling the NOL carryforward against expected future income, and checking whether a short-term rental path (average stay of seven days or less, plus material participation) fits a household that cannot meet REPS. None of those is automatic. Run the numbers before you commission studies on every building at once.
California still has its own rules
California did not adopt the federal real estate professional rule. For California purposes, rental activities remain passive (see FTB Form 3801 instructions). A loss that is nonpassive on your federal return can still be passive on your California return.
California also does not fully follow federal bonus depreciation. A large federal cost-segregation benefit often means a California addition or other adjustment. Pair any REPS-plus-cost-seg plan with a California projection, not only a federal one.
What this means for Los Angeles investors
If you are weighing a cost segregation study in 2026, ask three questions in order:
- Can one person in the household actually meet REPS this year, with a log that would hold up?
- Will material participation be met property by property, or do you need the grouping election on the original return?
- After REPS, how much of the projected first-year loss clears the $256,000 / $512,000 cap, and what does the NOL carryforward look like on both the federal and California returns?
If the answer to (1) is no, fix the hours plan or look at other strategies before you pay for a study aimed at offsetting W-2 income.
Frequently asked questions
Does cost segregation create real estate professional status?
No. Cost segregation changes depreciation timing. REPS depends on your hours and material participation under section 469(c)(7).
What is the excess business loss limit for 2026?
For tax years beginning in 2026, $256,000 ($512,000 if married filing jointly), per Rev. Proc. 2025-32 §4.31. Amounts above that are disallowed for the year and carried forward as a net operating loss.
Do my W-2 wages increase how much loss I can take under section 461(l)?
No. The excess business loss computation excludes income and deductions from the trade or business of performing services as an employee. Wages are often what you want to offset, but they do not raise the §461(l) threshold.
Is the disallowed excess business loss gone forever?
No. Section 461(l)(2) treats it as an NOL carryover to later years. Later use still follows NOL rules, including limits that can apply in the carryforward year.
Can I use REPS losses on my California return the same way?
No. California did not adopt REPS. Rental activities are passive for California purposes on Form FTB 3801, and California bonus depreciation rules also differ from federal law.
Do I still need a grouping election if I only own one rental?
Usually not for aggregation, because there is only one interest to test. You still need REPS (if you are relying on that path) and material participation in that rental. The election matters when you have multiple rental interests and want them treated as one activity.
Talk it through with us
Bring a draft cost segregation proposal, your latest return, and a honest hours estimate. We will map the federal stack, the 2026 cap, and the California adjustments before you spend on the study. Book a new client intro.
LaviCPA is a Los Angeles CPA firm for real estate investors. Shawn Lavi, CPA, is the firm's principal. Elias Lavi, CPA, is its founder and co-owner.