What to Do With Passive Loss Carryforwards
If you’ve invested in rental real estate or other passive activities, you may have accumulated passive losses over the years that you couldn't deduct due to IRS limitations. These are called passive loss carryforwards, and while they might feel like “dead weight” on your tax return, they can actually be a powerful tax-saving tool—if used wisely.
What Are Passive Loss Carryforwards?
Under the passive activity loss rules (IRC §469), passive losses can generally only offset passive income. If your passive losses exceed your passive income for the year, the excess is not lost—it’s carried forward to future years.
Common Sources of Passive Losses:
Rental real estate expenses (e.g., depreciation, repairs)
Limited partnerships
Passive business investments where you don’t materially participate
So What Can You Do With These Losses?
Here are strategies to unlock the value of those carryforward losses:
1. Generate More Passive Income
If you can create passive income (e.g., by increasing rents, investing in new passive income properties, or through other passive ventures), you can offset that income with your accumulated losses—tax-free.
Example:
You sell a rental property for a $50,000 passive gain. You have $40,000 in passive losses carried forward. You’ll only pay tax on $10,000 of that gain.
2. Sell a Passive Activity (Trigger a Full Loss Release)
When you dispose of an entire passive activity in a fully taxable transaction, you can deduct all the suspended losses related to that activity, even if you don’t have other passive income.
Tip: The sale must be complete (entire interest) and taxable (not a 1031 exchange or installment sale unless fully taxed).
3. Become a Real Estate Professional (REPS Status)
If you qualify as a real estate professional and materially participate in your rentals, your passive losses may become non-passive, allowing you to use those carryforwards against your ordinary income like W-2 wages or business income.
Requirements include:
More than 750 hours of real estate activity per year
More than half your working hours in real estate activities
4. Group Activities Strategically
You may be able to group related passive activities into a single “activity.” This can help you unlock losses by treating them as one business, increasing your ability to offset gains or show material participation.
5. Track and Plan
Work with your CPA to:
Track your passive loss carryforwards annually
Plan your income-generating or disposition strategies to use them intentionally
Time major sales or status changes (like electing REPS) to take advantage
Bottom Line
Your passive loss carryforwards are not useless. They’re dormant tax assets that can be unleashed with proper planning. Whether you’re a rental property investor or passive business owner, talk to a tax advisor who understands how to activate those losses at the right time.