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texzen5
Level 2

Using passive activity losses in other investments to offset rental property sale gain

My rental home sale closes in 3 weeks. California resident. Approximately 430K taxable as capital gain.  Thinking of a 1031, but I have other passive investments in real estate that I will be making this year as a LP unrelated to this property that will see substantial passive activity losses due to bonus depreciation in Year 1. Enough to wipe out much, if not all, of the 430K. 

 

Can I offset my 430K capital gain with all of my passive losses that occur throughout 2021? 

 

I'm also considering a partial 1031 exchange. Can passive losses be applied to remaining boot?

 

I've searched a great deal and found conflicting information. This suggests I can.

 

The tax rules provide that you may deduct your suspended passive losses from the profit you earn when you sell your rental property. To take this deduction, you must sell "substantially all" of your rental activity. If you own only one rental property and sell it, then you can take the deduction because that property is your entire rental activity. The same holds true if you own several properties and treat them each as separate activities for tax purposes.

 

Sincere thanks for helping me tax strategize. 

 

Best,

Paul 

 

ps Side note: is real estate professional status relevant here (pro or con)? I do not think I will qualify in 2021. Does it matter? 

1 Best answer

Accepted Solutions
Mike9241
Level 15

Using passive activity losses in other investments to offset rental property sale gain

passive losses from other properties or activities can not be used to offset capital gains from the sale of this property. however, any suspended passive losses on this property will be usable unless you do a 1031 exchange in which case the suspended PAL on this property will carry over to the replacement property.

the sale has to be fully taxable to release the suspended PAL

 

 

 

from your link as modified 

If you own rental properties that lose money, your losses are classified as passive losses for tax purposes. They are deductible only against other passive income you earn during the year. (capital gain from selling rental properties are not passive - boot would be taxed as a capital gain) So, if you don't have sufficient rental income or other passive income (income from a business in which you don't actively participate), you can't deduct these losses in the year you incur them—bad news taxwise.

  

 

a real estate professional does matter because they are not subject to the PAL rules for rental real estate.

 

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4 Replies
Mike9241
Level 15

Using passive activity losses in other investments to offset rental property sale gain

passive losses from other properties or activities can not be used to offset capital gains from the sale of this property. however, any suspended passive losses on this property will be usable unless you do a 1031 exchange in which case the suspended PAL on this property will carry over to the replacement property.

the sale has to be fully taxable to release the suspended PAL

 

 

 

from your link as modified 

If you own rental properties that lose money, your losses are classified as passive losses for tax purposes. They are deductible only against other passive income you earn during the year. (capital gain from selling rental properties are not passive - boot would be taxed as a capital gain) So, if you don't have sufficient rental income or other passive income (income from a business in which you don't actively participate), you can't deduct these losses in the year you incur them—bad news taxwise.

  

 

a real estate professional does matter because they are not subject to the PAL rules for rental real estate.

 

texzen5
Level 2

Using passive activity losses in other investments to offset rental property sale gain

Thanks for the answer, Mike. 

edli6789
Returning Member

Using passive activity losses in other investments to offset rental property sale gain

Assuming taxpayer is not a real estate professional, doesn't below seem to indicate that the capital gain from this sale can be offset by passive activity losses from other activities?

 

https://www.irs.gov/pub/irs-mssp/pal.pdf

 

Pg 79/154 from IRS Audit Guide:
"Passive losses are generally deductible only to the extent of passive income. However, current and suspended losses are fully deductible if there is a “qualifying disposition.” Under IRC § 469(g), a “qualifying disposition” requires three criteria:
1. Disposition of an entire interest (or substantially all[1])
2. In a fully taxable event (where all gain/loss is realized and recognized).
3. To an unrelated party.
If these three tests are met, losses are fully deductible against non-passive income (unless the taxpayer has basis limitations). Thus, in the year of disposition, losses allocable to the passive activity may offset portfolio and other investment income or may become part of a net operating loss. We have no regulations governing dispositions. Thus, we must look to IRC § 469(g) and legislative history[2] for guidance."

Pg 85/154 from IRS Audit Guide: "Reg. § 1.469-2T(c)(2)(i)(A)(2): Gain on disposition generally is passive income if the activity was a passive activity in the year of disposition"

 

Pg 84/154 from IRS Audit Guide: "Gain on Form 4797 and Schedule D should first offset losses from the same activity. If any gain remains, it offsets losses from other unrelated passive activities."

 

RobertB4444
Expert Alumni

Using passive activity losses in other investments to offset rental property sale gain

The IRS views capital gains and losses as different from passive activity real estate gains and losses.  You can tell this because your real estate losses - provided you meet certain conditions - can be used to offset regular income for a lot more than $3,000 while capital losses can't.  What the code sections you're quoting have to do with is offsetting gains from the same type of investments against losses.  So long term capital losses must first offset long term gains before they can be netted against short term gains.  And if you have two rental properties losses from one can offset gains from the other.  

 

Here is TurboTax's breakdown on capital gains and losses.

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