26 U.S.C. § 461 — General rule for taxable year of deduction

(a) General rule. You deduct an expense or credit in the tax year that is correct under your accounting method. (b) Special rule in case of death. If a taxpayer dies while using an accrual method, and an amount only becomes deductible because of the death, that amount cannot be deducted on the return for the period that includes the date of death. (c) Accrual of real property taxes. (1) If you use an accrual method, you can choose to spread a real property tax that covers a set period evenly over that period, instead of deducting it all at once. (2) You can make this choice two ways. (A) Without IRS approval, for the first year you owe real property taxes, as long as you make the choice by your filing deadline (including extensions). (B) With IRS ("the Secretary") approval, at any time. (d) Limit on speeding up tax accruals. (1) Suppose a local government changes its rules after December 31, 1960, so that a tax would accrue earlier than before. An accrual-method taxpayer must still treat the tax as accruing at the original, later time, under IRS regulations. (2) This limit does not apply if it would completely stop anyone — including a later owner — from ever counting the tax, under IRS regulations. (e) Dividends or interest on certain deposits. Mutual savings banks without stock, building and loan associations, and cooperative banks usually cannot deduct dividends or interest paid on withdrawable deposits for a period of more than 12 months, unless IRS regulations say otherwise. Any amount blocked this way is deducted instead in whatever later year the IRS decides fits. (f) Contested liabilities. Say a taxpayer disputes a debt, pays money or transfers property to cover it while the dispute continues, the dispute is still going after the transfer, and — except for the dispute — a deduction would otherwise be allowed for that year or an earlier one (applying subsection (h) first). Then the deduction is allowed in the year of the transfer. This rule does not apply to foreign income, war-profits, or excess-profits taxes. (g) Prepaid interest. (1) If you use the cash method, and you prepay interest that, under IRS regulations, covers a period after the end of this tax year, you cannot deduct it now. You must capitalize it and treat it as paid in the later period it covers. (2) Exception: this does not apply to "points" paid on a loan to buy or improve your main home, if paying points that way is the normal business practice in that area and the amount is not more than what is usually charged there. (h) Liabilities not incurred before economic performance. (1) Even if all the facts needed to fix a liability have happened (the "all events test"), you cannot treat the amount as incurred before "economic performance" actually occurs. (2) Unless IRS regulations say otherwise, economic performance happens as follows. (A) If someone else provides you services or property, it happens as they provide it; if you're using someone else's property, it happens as you use it. (B) If you must provide property or services to someone else, it happens as you provide them. (C) For workers' compensation and tort liabilities, it happens only when you actually make the payment — rules (A) and (B) do not apply to these. (D) For any other liability, it happens whenever IRS regulations say. (3) Exception for recurring items. Despite rule (1), an item counts as incurred in a year if: the all-events test is met that year; economic performance happens within a reasonable time or 8½ months after year-end, whichever is shorter; the item is recurring and the taxpayer always treats this kind of item the same way; and either the item is not "material" or accruing it early matches income better than waiting. How the item is shown on financial statements counts toward that "better match" decision. This recurring-item exception never applies to workers' compensation or tort liabilities. (4) The "all events test" is met when every fact needed to fix the liability, and its exact amount, is known with reasonable accuracy. (5) None of subsection (h) applies to an item for which some other part of the tax code specifically allows a deduction for a reserve for estimated expenses. (i) Special rules for tax shelters. (1) The recurring-item exception in (h)(3) never applies to a tax shelter. (2) For drilling an oil or gas well, a tax shelter's economic performance is treated as happening in the year paid if drilling starts within 90 days after that year ends. But the deduction is capped: a partnership tax shelter must use each partner's "cash basis" (defined below) instead of the usual basis limit, and other tax shelters get a similar cap under IRS regulations. A partner's cash basis equals their basis in the partnership, but ignoring partnership debts and ignoring money the partner borrowed that was arranged by the partnership or its organizers, or secured by partnership assets. (3) "Tax shelter" means: any enterprise other than a C corporation whose ownership interests were offered for sale in a registered securities offering; certain investment syndicates; or a shelter as defined elsewhere in the tax code. (4) For farming businesses, a different test — the "farming syndicate" definition in subsection (k) — is used instead of the usual tax-shelter test. (5) "Economic performance" here means the same thing it means in subsection (h). (j) Cap on excess farm losses. (1) If a non-corporate taxpayer receives certain farm subsidies in a year, they cannot deduct any "excess farm loss" for that year. (2) A disallowed loss simply carries forward and counts as a farming deduction next year. (3) "Applicable subsidy" means certain federal farm-program payments or Commodity Credit Corporation loans. (4) "Excess farm loss" is the amount by which farming deductions exceed the sum of farming income plus a "threshold amount." The threshold amount is the greater of $300,000 ($150,000 if married filing separately) or the taxpayer's net farm income over the prior five years, with detailed rules for handling carried-forward losses and taxpayers whose filing status changed. (5) For partnerships and S corporations, this limit is applied to each partner or shareholder individually, using their share of the entity's farm income, loss, and subsidies. (6) The IRS can require extra reporting to enforce this. (7) This limit is applied before the separate passive-activity-loss rules in section 469. (k) "Farming syndicate" defined. (1) A partnership or other non-corporate farming enterprise is a farming syndicate if its interests were offered in a registered securities sale, or if more than 35% of its losses go to limited partners or "limited entrepreneurs." (2) Several kinds of interests do not count as "limited" for that 35% test: interests tied to at least five years of active farm management, a farmer's own residence-farm, related livestock processing, another farming business of an already-active farmer, and certain interests held by family members (as defined in section 267(c)(4)) of such an active farmer. Where one farm replaces or is added to another, both count as one farm. (3) "Farming" has the meaning given in section 464(e). (4) A "limited entrepreneur" is someone who holds an interest other than as a limited partner but does not actively help manage the enterprise. (l) Cap on excess business losses of non-corporate taxpayers. (1) For tax years 2018 through 2026, the farm-loss cap in subsection (j) is turned off. Instead, for tax years 2021 through 2026, a non-corporate taxpayer cannot deduct any "excess business loss" for the year. (2) A disallowed loss is instead carried forward as part of a net operating loss under section 172(b). (3) "Excess business loss" is the amount by which a taxpayer's business deductions (not counting net-operating-loss or section 199A deductions, and not counting anything from working as an employee) exceed the sum of business income plus $250,000 ($500,000 on a joint return). Losses from selling capital assets do not count as deductions here; gains from selling capital assets count only up to the smaller of the business-related capital gain or total capital gain. Starting in 2026, the $250,000 figure is adjusted upward each year for inflation and rounded to the nearest $1,000. (4) For partnerships and S corporations, this limit applies to each partner's or shareholder's share of the entity's income, gain, deduction, or loss. (5) The IRS must require whatever extra reporting is needed to enforce this. (6) This limit is applied after the passive-activity-loss rules in section 469.