Use of prior partnership Passive Losses after becoming Active

[sebekjohn-gmail-com]

I became a passive investor in a LLC initially which generated prior-year Passive Losses.  I later became an Active partner for the remaining years we held this company investment (so losses for those years were taken in the year incurred, and the prior passive losses carried over).  In 2024, we sold this company.  How do I report this in turbo tax once I get my K-1?  I am of the understanding that upon disposition of this asset, I should be able to offset the capital gain by the amount of the prior-year "suspended" passive losses recorded from this asset...correct?

[MinhT1]

Yes, you are correct.

You can fully deduct these suspended passive losses when you sell your investment in a qualifying disposition.

Under IRC § 469(g), a “qualifying disposition” requires three criteria:

1. Disposition of an entire interest (or substantially all)

2. In a fully taxable event (where all gain/loss is realized and recognized).

3. To an unrelated party.

In order to release the suspended losses, there must be a complete disposition to an unrelated party in which all gain or loss realized is recognized. In other words, the gain or loss must be recognized, but not necessarily included in gross income.

Please read this IRS document for more information.

[sebekjohn-gmail-com]

MinhT1,

Thanks for your reply.  This investment was sold to a third party as an asset purchase on an "installment" basis.  Investors received an ~ 75% payout upon the sale Closing date (Nov 2024), and we will get another ~25% payout upon the "earn-out" date mid 2025.  Do you agree this meets the "substantially all" disposition criteria at the first Closing date of Nov 2024 given most of the gain on sale will be realized in 2024?

[PatriciaV]

Yes. If you fully liquidated your ownership of the company, the sale qualifies as substantially all of your interest. 

The installment nature of the payout shouldn't matter, as long as there is no doubt that the transfer of ownership is final. 

Also, if the gain is obvious and unlikely to change, it doesn't matter when you actually report the final piece of the installment sale gain on your tax return.