Passive activity loss: Overview and FAQs

What is a passive activity loss?

A passive activity loss (PAL) is a tax loss from a business activity or rental activity in which you do not materially participate. In other words, if you’re not regularly, continuously, and substantially involved in the activity, the IRS may treat it as passive.

What counts as a passive activity?

Common examples of passive activity include:

• Rental real estate, with some exceptions. Most rental real estate activities are generally treated as passive by default, even if the taxpayer participates, unless an exception applies.
• Investments in partnerships, LLCs, or S corporations may be passive if the taxpayer does not materially participate in the underlying activity.
• Businesses where the taxpayer invests money but doesn’t help run day-to-day operations.

What is material participation?

Material participation is an IRS standard used to determine whether you are sufficiently involved in a business or income-producing activity for it to be treated as nonpassive rather than passive for tax purposes. Time spent as an investor alone, such as reviewing statements or monitoring performance, generally does not count toward material participation.

The IRS provides seven material participation tests, and satisfying any one of them may qualify an activity as nonpassive. Common examples include:

• 500-hour test. You participate in the activity for more than 500 hours during the year.
• 100-hour and “more than anyone else” test. You participate more than 100 hours, and no one else participates more than you.
• Substantially all participation test. Your participation constitutes substantially all the participation in the activity.

These are only some of the seven tests available under the rules, and additional tests may apply, including for taxpayers with multiple or grouped activities.

How do you calculate passive activity loss?

Passive activity loss is generally calculated by subtracting total passive activity expenses from total passive income, then applying the IRS passive loss limitation rules, typically reported on IRS Form 8582.

Step 1: Identify your passive activities

First, determine which activities are considered passive. These generally include activities where you do not materially participate, such as:

• Rental real estate, with exceptions
• Limited partnership interests
• Certain LLC or S corporation investments

If you meet material participation tests — for example, generally 500+ hours, or in some cases 100+ hours and more than anyone else — the activity may be nonpassive and these rules may not apply.

Step 2: Calculate net income or loss for each activity

For each passive activity, calculate:
Passive income – passive expenses = net passive income or loss

Example:
Rental income — $18,000
Deductible expenses — $28,000
Net passive loss = $10,000

Step 3: Aggregate all passive activities

Next, combine income and losses from all passive activities.

Example:
Rental loss — $10,000
Passive income from another investment — $6,000
Net passive loss subject to limitation = $4,000

Step 4: Apply passive activity loss limitations

In general, passive losses can offset passive income, but not active income, such as wages.

If losses exceed passive income, the excess is generally disallowed for the current year and suspended, then carried forward to future years.

In the example above:
Current deductible loss — $6,000
Suspended loss carried forward — $4,000

Important: Passive loss rules may not be the first limitation applied

Before passive activity loss rules are applied, losses may first be limited by other tax rules, including:

• Basis limitations, which may restrict deductions to your tax basis in the activity.
• At-risk rules, which may limit losses to amounts you have economically at risk.

Only after those rules are applied are the passive activity loss limitations generally considered.

Step 5: Check for special allowances

A key exception applies to some rental real estate owners.

If you actively participate in rental real estate, you may be able to deduct up to $25,000 of losses against nonpassive income, subject to modified adjusted gross income (MAGI) limitations for passive activity loss purposes:

• The full allowance of up to $25,000 may be available for eligible taxpayers, subject to modified adjusted gross income phaseouts.
• For many taxpayers, the allowance phases out between $100,000 and $150,000 MAGI.
• For married taxpayers filing separately who lived apart all year, the special allowance is generally limited to $12,500 and phases out between $50,000 and $75,000 of MAGI; if spouses lived together at any time during the year, the allowance is generally unavailable.

What happens to suspended losses?

Disallowed losses are not usually lost. They carry forward until:

• You have passive income to absorb them, or
• You dispose of your entire interest in the activity in a taxable transaction to an unrelated party, which may release suspended losses.

Where are passive activity loss limitations reported?

Passive activity loss limitations are generally calculated on Form 8582, which determines:

• Current allowable losses
• Disallowed losses
• Carryforwards to future years

What is Form 8582?

IRS Form 8582, Passive Activity Loss Limitations, is a tax form used by individuals, estates, and trusts to calculate the amount of passive activity losses that can be deducted from their taxes. It ensures that losses from passive activities, like rental real estate or limited partnerships, only offset passive income, restricting excessive deductions.

When is Form 8582 required?

Taxpayers generally use Form 8582 when passive activity loss limitations may apply, including when passive losses exceed passive income. Corporations subject to the passive activity rules generally use Form 8810 instead.

How do you fill out Form 8582?

To complete Form 8582, taxpayers generally begin by identifying passive activities, combining passive income and losses, and determining whether current-year losses are limited. The form then helps calculate allowable losses and suspended losses carried forward.

For detailed instructions and the latest updates, refer to the official IRS Instructions for Form 8582. 

When can you deduct passive activity losses?

Passive activity losses are generally deductible when they can be used against passive income or qualify for an exception under the rules. If neither applies, the losses are typically suspended and carried forward.

You may generally deduct passive activity losses when:

• You have passive income. Passive losses can generally offset income from other passive activities. For example, losses from one rental property may offset income from another rental property or other passive investment income.
• You qualify for a special exception. Some taxpayers may be able to deduct passive losses against nonpassive income under specific exceptions. One common example is the $25,000 rental real estate allowance for eligible taxpayers who actively participate in rental real estate, subject to modified adjusted gross income (MAGI) limitations for passive activity loss purposes.
• The activity is not treated as passive. If you materially participate in the activity and it is treated as nonpassive, losses may not be subject to passive activity loss limitations and may be deductible, subject to other tax rules.
• You dispose of the activity in a qualifying taxable sale. Suspended passive losses may generally be released when you dispose of your entire interest in the passive activity in a fully taxable transaction to an unrelated party. This often occurs when taxpayers can use losses that were previously suspended.

What are the passive activity loss rules?

Passive activity loss rules restrict taxpayers from using losses from passive activities — for example, businesses where they do not materially participate, or most rental activities — to offset active income like wages or portfolio income. These losses can only offset income from other passive activities, with unused losses carried forward to future years or deducted upon complete disposition of the activity.

Can passive activity losses offset capital gains?

Generally, passive activity losses cannot offset portfolio capital gains, such as gains from selling stocks or mutual funds. However, capital gain from the sale of an interest in a passive activity may be treated differently. If the gain is passive activity income, passive losses may be available to offset it. Suspended losses may also be released when the taxpayer disposes of the entire interest in a passive activity in a fully taxable transaction to an unrelated party.

Can active losses offset passive income?

In many cases, yes — but only if the losses are otherwise allowable under the tax rules.

Key details on offsetting income:

• Active losses versus passive income. If you have deductible losses from a business in which you materially participate, those losses may generally offset passive income, subject to other applicable limitations.
• Passive losses versus active income. Generally, passive losses can only offset passive income. They cannot be used to offset wages or active business income.
• Suspended losses. If passive losses exceed passive income, the unused loss is "suspended" and carried forward to future years to offset future passive income.
• Exception — sale of property. When you dispose of your entire interest in a passive activity, like selling a rental property, any suspended losses from that activity can be used to offset both passive and active income.
• Real estate professionals. A taxpayer who qualifies as a real estate professional may treat rental real estate losses as nonpassive only for rental activities in which the taxpayer also materially participates.

Unused passive activity losses generally carry forward until they are absorbed by passive income or released upon a qualifying disposition.

However, nonpassive losses may still be limited or deferred by other provisions before they can be used. These may include:

• Basis limitations
• At-risk rules
• Excess business loss limitations
• Other activity-specific or entity-level restrictions

Can passive activity loss offset ordinary income?

Generally, passive activity losses cannot offset ordinary income, such as wages, salary, or active business income. However, exceptions may apply, including the $25,000 rental real estate allowance for eligible active participants, real estate professional treatment, and the release of suspended losses upon a qualifying taxable disposition.

Do passive activity losses carry forward?

Yes. Passive activity losses carry forward to future tax years if they cannot be used in the current year due to a lack of passive income. These "suspended" losses are carried forward and can be used to offset passive income in future years or are fully released upon the taxable disposition of the entire activity.

Suspended losses are tracked year to year and reported through Form 8582 when applicable.

How can you release a suspended passive activity loss?

Suspended passive losses are generally released when you:

• Generate passive income to absorb them
• Dispose of your entire interest in the activity in a fully taxable transaction to an unrelated party.

In limited cases, changes in participation may affect whether future losses are passive or nonpassive, though prior suspended losses generally are not automatically released solely because an activity changes status. 

How can you avoid passive activity loss limitations?

Taxpayers may be able to avoid or reduce passive activity loss limitations by:

• Materially participating in the activity. If you work in a business for more than 500 hours during the year, or meet other criteria like 100+ hours and being the primary worker, the activity is considered active, not passive.
• Using the $25,000 rental real estate exception. If you actively participate in managing rental property decisions like approving tenants or authorizing repairs, you may qualify to deduct up to $25,000 of losses against nonpassive income, subject to income phaseouts. This can be a valuable exception for smaller landlords.
• Qualifying as a real estate professional. For qualifying taxpayers, the real estate professional rules can be one of the most significant ways to avoid passive loss treatment on rental activities. If you meet the applicable time and participation requirements and materially participate in the rentals, losses may be treated as nonpassive. Because these rules are highly technical and heavily scrutinized, documentation is critical.
• Generating passive income to absorb losses. Even if losses remain passive, generating passive income from other investments may allow losses to be used currently. Examples include income from other rental properties, passive partnership income, and passive business investments. While this does not eliminate the PAL rules, it can reduce their impact.
• Evaluating grouping elections. In some cases, IRS grouping elections may allow multiple undertakings to be treated as a single activity for material participation purposes. This can sometimes help taxpayers meet participation thresholds that might not be met on a stand-alone basis. Because grouping decisions can have long-term consequences, they should be evaluated carefully.
• Planning for a taxable disposition. A properly structured taxable disposition of a passive activity can release suspended losses that have been built over time. While this does not avoid the limitation upfront, it can be an important strategy for unlocking deferred deductions.

At the end of the day, the right strategy depends heavily on the type of activity, income levels, and overall tax picture. In many cases, passive activity loss planning is less about avoiding the rules and more about structuring activities so losses are used more efficiently.

Where can tax professionals get help on passive activity losses?

Passive activity loss rules can be difficult to apply, especially when limitations, suspended losses, carryforwards, and disposition rules all come into play.

Thomson Reuters UltraTax CS can help tax professionals calculate and report passive activity losses more accurately on tax returns. Together with the online reference Federal Income Taxation of Passive Activities, tax professionals can feel supported in researching the rules and identifying planning opportunities to minimize tax consequences.

Together, these resources can help tax practitioners navigate passive activity loss issues with greater clarity, efficiency, and confidence.

We last updated this information on 06/03/2026.