Suspended passive losses: what a cash sale, a 1031 and an installment sale each do with them
By Hans Goldstein, EA, founder, Retirement Literacy Foundation · Updated
Admitted to practice before the IRS.
What a suspended passive loss is
Rental losses are usually passive (IRC 469). When passive losses are larger than passive income, the excess cannot be deducted that year. It carries forward on Form 8582 as a suspended loss, attached to the rental that produced it.
The example
Assumptions: a married couple filing jointly with $90,000 of other ordinary income and no state income tax. They sell a rental for $650,000 with an adjusted basis of $350,000: a $300,000 gain, of which $100,000 is unrecaptured Section 1250 gain from depreciation and $200,000 is long-term gain. Their Form 8582 carries $80,000 of suspended losses for this property.
| Without the losses | With $80,000 freed | |
|---|---|---|
| Tax on the depreciation recapture slice | $17,700 | $8,840 |
| 3.8% NIIT | $5,320 | $2,280 |
| Total federal tax added | $53,020 | $31,515 |
Four ways to sell, side by side
| Cash sale | 1031 exchange | Installment sale, 10 years | 1031 with $150,000 boot paid in installments | |
|---|---|---|---|---|
| When the losses are used | All in the year of sale | Not now; they stay suspended | Year by year as gain is reported | Against the boot gain as it arrives |
| Tax on the gain, with the losses | $31,515 | $0 now | $2,401 | $2,400 |
| Tax on the gain, without the losses | $53,020 | $0 now | $12,000 | $12,000 |
| Tax saved by the losses | $21,505 | $0 now | $9,599 | $9,600 |
| Interest in the payments, and tax on it | None | None | $233,142, taxed $36,701 | $53,802, taxed $6,455 |
Figures are the federal income tax and 3.8% net investment income tax added by the sale, computed with 2026 federal brackets (IRS Rev. Proc. 2025-32) held flat for every payment year, standard deduction applied, no state tax. The 6% payout rate is an assumption for illustration, not a quote or an offer.
Cash sale
All three conditions of IRC 469(g)(1)(A) are met when you sell your entire interest, in a fully taxable sale, to an unrelated buyer. The full $80,000 is deductible that year.
Installment sale
Each year's gain is passive income, so the losses absorb it first; the rest are released in the ratio of that year's gain to the gain still to come (IRC 469(g)(3)). In this example the losses are fully used by year 4.
1031 exchange
A 1031 is not fully taxable, so the losses are not freed. They are not lost either. Gain recognized on boot is passive income (Temp. Treas. Reg. 1.469-2T(c)(2)), which the losses can offset, and any remaining losses wait for a later fully taxable sale.
Other events
- Sale to a relative: losses stay suspended until the relative sells to an unrelated buyer (IRC 469(g)(1)(B)).
- Death: losses are freed, but only to the extent they exceed the step-up in basis (IRC 469(g)(2)).
- Gift: losses are not freed; they are added to the recipient's basis (IRC 469(j)(6)).
Gray areas
Reasonable tax professionals disagree on these points. Both views are shown; neither is a recommendation.
Several rentals grouped as one activity
One view: If the returns grouped the rentals as one activity (Treas. Reg. 1.469-4), selling one building is not a sale of the entire interest, so its losses stay suspended.
The other view: Some practitioners treat a sale of substantially all of a grouped activity as enough.
Common ground: Check how prior returns grouped the rentals before counting on a release.
Do freed losses also lower the 3.8% NIIT?
One view: Yes: losses allowed on disposition are deductions allocable to rental income and reduce net investment income (Treas. Reg. 1.1411-4). The example uses this view.
The other view: Losses from years when the rental was not passive for NIIT purposes, such as years as a real estate professional, may be treated differently.
Common ground: The regular income tax saving does not depend on this question.
Related guides: suspended passive losses when you sell (Form 8582) and structured installment sale vs 1031 exchange.
Frequently asked questions
Can suspended passive losses offset depreciation recapture?
Yes. After a qualifying sale frees them, they offset any income, including recapture.
Are suspended passive losses lost in a 1031 exchange?
No. They stay suspended, can offset passive income such as boot gain, and are freed in a later fully taxable sale.
Does an installment sale free the losses?
Gradually. Each year's gain absorbs losses, and the rest are released in proportion to the gain reported (IRC 469(g)(3)).
Do suspended passive losses expire?
No. They carry forward until used against passive income or freed by a qualifying disposition.
What if the rental is sold to a family member?
The losses stay suspended until the family member sells to an unrelated buyer (IRC 469(g)(1)(B)).
What happens to suspended losses at death?
They are freed, reduced by the amount of the step-up in basis (IRC 469(g)(2)).
Sources
- IRC 469, passive activity losses (Cornell LII)
- Temp. Treas. Reg. 1.469-2T, passive activity gross income (eCFR)
- Treas. Reg. 1.469-4, defining an activity (eCFR)
- Treas. Reg. 1.1411-4, net investment income (eCFR)
- IRS Publication 925, Passive Activity and At-Risk Rules
- IRS Instructions for Form 8582
- IRC 453, installment method (Cornell LII)
- Treas. Reg. 1.453-12, unrecaptured Section 1250 gain in installment sales (eCFR)
- IRC 1(h)(6), unrecaptured Section 1250 gain (Cornell LII)
- IRC 1411, net investment income tax (Cornell LII)
- IRC 1031, like-kind exchanges (Cornell LII)
- IRS Rev. Proc. 2025-32, 2026 inflation adjustments
Links checked October 26, 2026. This guide is general education from a nonprofit. It is not tax, legal or investment advice for your situation, and nothing here is an offer to sell any product. Rules change; confirm current law with your own tax professional before you act.