A net operating loss (NOL) may arise if a construction business’s deductible project costs, overhead and other allowable expenses exceed its income for the year. This can occur because of reduced cyclical demand for certain services, the timing effects of long-term contract accounting, weather-related disruptions, cost overruns, or job-specific conflicts or incidents.

Although inherently negative, NOLs come with a potential silver lining: You may be able to carry them forward and claim a deduction to reduce taxable income in future years.

Ground rules

The tax rules governing NOLs are intended to address inequities that sometimes arise between businesses with typically stable year-to-year income and those with fluctuating income, which is often the case in the construction industry. Essentially, they allow businesses with variable revenue to smooth out their income and losses — and, in turn, their tax liability — over multiple years.

NOLs are generally caused by tax deductions related to your 1) trade or business, 2) rental property, or 3) casualty or theft losses resulting from a qualified disaster. The IRS identifies losses from operating a business as the most common reason for NOLs.

Precisely how you may claim an NOL depends on business structure. Many construction businesses are structured as pass-through entities such as partnerships, S corporations and most types of limited liability companies. An NOL deduction can’t be claimed by a pass-through at the entity level. However, partners and shareholder-employees can use their separate shares of the business’s income and deductions to calculate their individual NOLs. When doing so, the following are generally disallowed:

• Capital losses that exceed capital gains,
• The exclusion for gains from the sale or exchange of qualified small business stock,
• Nonbusiness deductions (for example, charitable contribution deductions, mortgage interest deductions or standard deductions) that exceed nonbusiness income,
• The NOL deduction itself, and
• The Section 199A qualified business income deduction.

Sole proprietors may also claim NOL deductions on their individual returns.

C corporations may claim NOL deductions at the entity level. For such companies, NOLs are determined without considering 1) dividends-received deductions (calculated without regard to the aggregate limitations that typically apply to the deductions), 2) the deduction for foreign-derived deduction-eligible income, or 3) the NOL deduction itself.

Remember, state NOL rules may differ from the federal rules. This is highly relevant to construction businesses that operate in multiple states.

Recently revised limit

The Tax Cuts and Jobs Act of 2017 significantly revised the NOL rules, and the One Big Beautiful Bill Act of 2025 made those changes permanent. Currently, for NOLs arising after 2020, each deduction is limited to 80% of your taxable income for the year under most circumstances. So, even if you have enough post-2017 NOLs to carry forward and offset all taxable income for a year, the NOL deduction generally can’t reduce taxable income below 20% of taxable income calculated before the NOL deduction.

In addition, most NOLs can’t be carried back, but they can be carried forward indefinitely. If your NOL “carryforward” isn’t fully absorbed in a given year, the unused portion may become an NOL “carryover” applicable to the next eligible year. When multiple NOL carryforwards are available, they usually must be applied in the order incurred, beginning with the earliest.

Sole proprietors and owners of construction businesses structured as pass-through entities may also be subject to the excess business loss limit. This is usually applied at the individual owner level rather than at the entity level. In most cases, the limit means business losses of these noncorporate taxpayers can offset only business-related income or gain up to an inflation-adjusted threshold.

For 2026, the threshold is $256,000 ($512,000 if married and filing jointly). Any remaining losses are treated as an NOL carryforward applicable to the next tax year. Because excess business losses are subject to the 80% income limitation on NOLs, taxpayers can’t fully deduct them.

Glass half full

Contractors work in an industry with tight profit margins, fluctuating cash flow and considerable risk. If your construction business incurs an NOL, look at it as a “glass half full” situation and contact your tax advisor for help determining whether it might benefit you in a future year.

Take a wide view of tax planning

When looking to leverage your construction business’s net operating losses (NOLs), be sure to account for the interplay with other tax provisions. What might seem like a smart NOL move could end up reducing the benefit of other tax breaks, and vice versa.

For example, say you buy a major piece equipment that qualifies for 100% first-year bonus depreciation. Claiming bonus depreciation may create or increase a current-year loss. If that loss becomes an NOL carryforward, the resulting deduction in a later year may be subject to the 80% taxable-income limitation. (See main article for further details.) In some cases, opting out of bonus depreciation or using another depreciation strategy may produce a better overall tax result.

Bottom line: Work closely with your tax advisor to manage your carryforwards. They can help you improve cash flow and provide a hedge against the income volatility so common in the construction industry. But there may be times when other strategies are more beneficial.

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