Passive Loss

What is a passive loss?

A passive loss is a tax loss from a business activity in which you do not materially participate. Rental real estate and limited partnership investments commonly generate passive losses. The passive activity loss rules generally prevent using passive losses to offset wages, business income, or portfolio income. Passive losses can only offset passive income, with limited exceptions.

Why passive losses get trapped

Congress enacted passive loss rules to stop taxpayers from using tax shelter losses to eliminate tax on unrelated income. Before these rules, investors bought into partnerships generating paper losses that offset wages. Now, passive losses are suspended until you have passive income or dispose of the activity. Your K-1 may show losses you cannot currently deduct.

Freeing up passive losses

Generate passive income from other investments to absorb suspended losses. Qualify as a real estate professional to treat rental activities as non-passive. Dispose of the entire activity in a taxable transaction to release all suspended losses. Plan with your accountant to understand when suspended losses will become usable. The losses are not lost, just delayed until circumstances allow their use.