Passive Loss
Definition and meaning of Passive Loss in real estate.
A passive loss is a financial loss generated from an investment activity in which the taxpayer does not materially participate, such as rental real estate or limited partnership ventures.
In more detail
Under Internal Revenue Service rules, taxpayers generally cannot use passive losses to offset active income like salaries or business profits. Instead, passive losses can only offset passive income, which includes rental income or investment gains from other passive activities. Unused passive losses can be carried forward to future tax years or deducted when the taxpayer sells their entire interest in the property.
However, real estate professionals and individuals who actively manage their rentals may qualify for exceptions that allow them to deduct some losses against active income.
Key facts
| Category | Real Estate Investing |
|---|---|
| Governing Agency | Internal Revenue Service (IRS) |
| Tax Rule | Cannot offset active or portfolio income in most cases |
| Exceptions | Real estate professionals and active participation allowances |
An investor had a rental property that generated a rental loss due to depreciation and interest expenses, which the investor carried forward to the next year since their active income was too high to claim the loss immediately.
Frequently asked questions
Can I ever deduct rental losses against my regular salary?
Yes, if you actively participate in managing the rental property and your modified adjusted gross income is below a set threshold, you may deduct up to a certain amount in rental losses. This allowance phases out as your income increases.
What happens to suspended passive losses when I sell the property?
When you sell your entire interest in a passive activity to an unrelated party, any suspended or unused passive losses from that activity can generally be fully deducted against your income in the year of the sale.