Suspended Losses of Former Passive Activities

Posted by Lee Reams Sr. on

Former passive activities are not too common, but can cause confusion. There are several ways in which a tax return can include an item which is not passive on the current return, but which was passive at some time in the past. For example, tax-deferred exchanges can pass losses from one activity to another, transfers in a divorce, a change in business format and the conversion of a property from rental to personal use are a few possibilities that can cause this.  When there are suspended losses from such activities, a taxpayer must wait for one of three events to claim the losses:

  • Income from the same activity.  When the same activity produces net income, this will trigger use of former losses from the same activity.
  • Income from another passive activity. Form 8582 handles this automatically. Any excess net income from passive activities triggers the allowance of suspended losses from all other passives.
  • Disposition of the activity.  If the activity is disposed of in a fully taxable transaction, all suspended losses from that activity will be triggered.

Suspended Passive Losses – Former Principal Residence - In a taxpayer-friendly result in Chief Counsel Advice (CCA201428008), IRS has determined that suspended passive activity losses from the passive rental of a home which was formerly used as the taxpayer's principal residence, did not offset gain excluded under Code Sec. 121 on the property's sale.  This leaves suspended losses available to offset taxable passive income in the future. If IRS had reached a contrary result, the suspended losses would be wasted offsetting gain that wasn't taxable because it had already been excluded under the home sale exclusion.