Passive Loss Rules for Real Estate Investors

Under the passive activity rules in Section 469 of the tax code, a loss from a rental property can offset only passive income, such as profit from your other rentals, unless an exception applies. One exception lets you deduct up to $25,000 of rental losses a year against wages and other income if you actively participate in managing the property, but that allowance shrinks by $1 for every $2 of modified adjusted gross income (MAGI) above $100,000 and is gone at $150,000. Losses you cannot use carry forward with no time limit, and they are freed up in full in the year you sell the property to an unrelated buyer in a fully taxable sale.

Which income a rental loss can offset

A rental is a passive activity no matter how many hours you spend on it, unless you qualify as a real estate professional or the property is a short-term rental with very short average stays (both covered in the last section). You have a rental loss when deductions such as depreciation, mortgage interest, and repairs exceed the rent you collect. That loss can offset:

• Net income from your other rentals.
• Income from a business you own but do not materially participate in, such as a limited partnership interest.
• Gain from selling property used in a passive activity.

It cannot offset nonpassive income: wages, profit from a business in which you materially participate, or portfolio income such as interest, dividends, and stock gains. Material participation means working in an activity on a regular, continuous, and substantial basis; IRS Publication 925 sets out seven tests for it, most of them based on hours.

Example: you own two rentals. One earns $6,000 after expenses and the other loses $10,000. The loss offsets the $6,000 profit. The remaining $4,000 is deductible against your other income only through the $25,000 allowance; otherwise it carries forward.

A purchase year can show a large loss, because 100% bonus depreciation applies again to property acquired and placed in service after January 19, 2025 that has a recovery period of 20 years or less, such as a rental's appliances, carpeting, and fences. Any part of that loss your passive income and the allowance cannot absorb carries forward. Bonus depreciation for real estate covers which components qualify.

The $25,000 allowance and the MAGI phase-out

You qualify for the special allowance if you or your spouse actively participate in the rental. Active participation is a lower bar than material participation: you make the management decisions, such as approving new tenants, setting rental terms, and approving expenses. You must also own at least 10% of the property by value, counting your spouse's share. Limited partners do not qualify.

The allowance drops by 50% of your MAGI above $100,000:

MAGI for this test is your adjusted gross income figured without passive activity income or loss and a few other items, such as taxable Social Security benefits and deductible IRA contributions; Publication 925 lists them all. The $25,000 and $100,000 figures are set in the statute and are not adjusted for inflation, so they are the same for 2026. A joint return gets one $25,000 allowance, figured on the couple's combined MAGI.

Example: a single landlord with $130,000 of MAGI and an $18,000 rental loss deducts $10,000 this year and carries the other $8,000 forward.

If you are married filing separately, you get no allowance if you lived with your spouse at any time during the year. If you lived apart all year, your maximum is $12,500, phasing out between $50,000 and $75,000 of MAGI.

How suspended losses carry forward and get released

A loss you cannot deduct this year is a suspended loss. It carries forward to each later year until one of these happens:

1. You have passive income from that property or another passive activity to absorb it.
2. Your MAGI falls enough for the $25,000 allowance to cover it.
3. The activity becomes nonpassive and has current-year net income. Its suspended losses can offset that income, with any remainder still subject to the passive-loss rules.
4. You sell your entire interest in the property to an unrelated buyer in a fully taxable transaction, meaning one in which you recognize all of your gain or loss. In that year, the property's suspended losses and its current-year loss become deductible against wages and any other income. If you or your preparer grouped several rentals as one activity, selling one of them is only part of your interest in that activity, so its losses are generally not freed up in full.

Example: you carry $40,000 of suspended losses on a duplex and sell it to an unrelated buyer for a $90,000 gain. All $40,000 is deductible in the year of sale, and the gain is taxed under the rules in capital gains tax on investment property.

Other ways of giving up a property treat its suspended losses differently:

Timing a sale to release suspended losses is one of the year-end moves in tax planning strategies for rental property income.

Reporting on Form 8582

Form 8582 figures how much of your passive loss you can deduct this year and allocates the unused loss among your rental activities. Keep every year's form, because each activity's carryforward is what you deduct when you later sell it. The allowed rental loss goes on Schedule E (Form 1040).

You can skip Form 8582 for a year if all of these are true:

• Your only passive activities were rental real estate in which you actively participated.
• Your total loss from them was $25,000 or less ($12,500 if married filing separately and living apart all year).
• Your MAGI was $100,000 or less ($50,000 if married filing separately).
• You have no losses carried over from earlier years and no passive activity credits.
• You hold no rental real estate interest as a limited partner or as a beneficiary of an estate or trust.

Exceptions: real estate professionals and short-term rentals

Real estate professionals. If more than half of your working hours, and more than 750 hours in the year, are in real property businesses in which you materially participate, your rentals are no longer automatically passive. Hours you work as an employee count only if you own more than 5% of the employer. Current-year losses from rentals in which you also materially participate can then offset wages and any other income. Qualifying does not release previously suspended losses against wages; they can offset current-year net income from the same activity, but any remainder stays subject to the passive-loss rules. Real estate professional status covers the tests and the time records the IRS expects.

Short-term rentals with average stays of 7 days or less. A property is not a rental activity under these rules if the average guest stay is 7 days or less, or 30 days or less when you provide significant personal services with the stays (services beyond what comes with a long-term rental; cleaning common areas and routine repairs do not count). To find the average, divide the total days rented by the number of separate rentals: 150 nights across 30 bookings averages 5 days. The property is then treated like a business, and its loss is nonpassive only if you materially participate. Two of the seven tests are more than 500 hours of work on it in the year, or more than 100 hours and at least as many hours as any other person, including cleaners and managers who own no part of it.

If you do not materially participate, the loss stays passive, and the $25,000 allowance does not apply, because the property is not a rental activity under these rules. If you or your family use the property personally for more than the greater of 14 days or 10% of the days it is rented at a fair price, the vacation home rules in IRS Publication 527 apply instead. Rental expenses above the rental income then cannot offset your other income and carry forward to the next year, and if you rent the property for fewer than 15 days, you report no rental income and deduct no rental expenses. The short-term rental tax guide covers those rules and how short-term rental income is reported.