Can you deduct passive losses when you sell?

The release rule

While an activity is passive, a loss you cannot use stays suspended and carries forward as a deduction from the same activity in later years. Publication 925 says that when you finally dispose of your entire interest in the passive or former passive activity, any passive activity losses that haven't been allowed, including current-year losses, are generally allowed in full. Passive credits do not get this release. Three conditions must all hold:

1. You dispose of your entire interest in the activity, not part of it.
2. The transaction recognizes all of the realized gain or loss, so a tax-deferred or tax-free exchange does not qualify.
3. The person acquiring the interest is not related to you.

Capital loss on the sale is separate

The release frees ordinary suspended passive deductions. The loss on the sale itself, if there is one, is a capital loss governed by its own rules, and for an individual a capital loss deduction is limited to capital gains plus the lower of $3,000 ($1,500 married filing separately) or the excess of capital losses over capital gains. The publication's example: Carter sold an entire 5% partnership interest to an unrelated buyer for $30,000 with an adjusted basis of $42,000, and had carried over $2,000 of ordinary passive deductions. The capital loss of $12,000 is limited to $3,000 this year, leaving a $9,000 capital loss carryover that is no longer subject to the passive rules. Carter's deductible loss for 2025 is $3,000 plus the $2,000 of released passive deductions, or $5,000. The checker above reproduces it.

Installment sales

If you sell your entire interest on the installment method, the loss is released in proportion to gain reported. Multiply your overall loss, not counting losses allowed in prior years, by a fraction: the numerator is the gain recognized this year and the denominator is the total gain from the sale minus gains recognized in prior years. The publication's example has a $10,000 total gain reported at $2,000 a year: 20% of the losses ($2,000 of $10,000) is allowed in year one and 25% ($2,000 of $8,000) of what remains in year two.

Gifts and death

If you give away your interest, the unused passive losses allocable to it cannot be deducted in any year. Instead, the basis of the transferred interest is increased by those losses, so the benefit moves to the recipient. If the interest passes because the owner dies, unused losses are allowed, to a degree, against the decedent's income in the year of death, but only to the extent they exceed the amount by which the transferee's basis is increased under the rules for property acquired from a decedent. The example: a transferee basis increase of $6,000 against $8,000 of unused losses leaves a $2,000 deduction on the decedent's final return. Step-up in basis can therefore consume the losses.

Partnerships and S corporations

Gain or loss on the disposition of a partnership interest is generally allocated to each trade or business, rental or investment activity in which the partnership owns an interest. If you dispose of your entire partnership interest, unallowed passive losses from it are generally allowed in full. They are also allowed if the partnership, other than a publicly traded partnership, disposes of all the property used in that passive activity. If you dispose of only part of the interest, gain or loss allocated to a passive activity is passive income or deduction in that year, including gain on a cash distribution above the adjusted basis of the interest. The same rules apply to S corporation stock.

Partial dispositions

The disposition of substantially all of an activity can be treated as a complete disposition of the part sold, if you can prove with reasonable certainty both the prior-year unallowed losses allocable to that part and the net income or loss for the year of disposition allocable to it. Grouping decisions matter here: if you grouped two activities into one, selling one is only a partial disposition.

Where the gain goes

Gain on selling property used in a passive activity is generally passive activity income, which can itself absorb suspended losses even when you do not meet every release condition. The publication has exceptions for property used in more than one activity in the prior 12 months and for substantially appreciated property (fair market value above 120% of adjusted basis combined with either use in a passive activity for 20% of the holding period or for the entire 24 months before disposition). Net passive income from renting property where less than 30% of its unadjusted basis is depreciable, such as land, is recharacterized as nonpassive.

Carrying losses until the sale

Until you sell, the suspended deductions are allocated to your activities for the next year in a manner that reasonably reflects the extent to which each continues the loss activity. When disallowed, a ratable portion of the loss from each loss activity is disallowed: if Terry's three activities produce losses of $9,000 and $16,000 and a profit of $4,000, the $21,000 net passive loss is disallowed and allocated $7,560 to the first loss activity and $13,440 to the second, each by its share of the $25,000 of gross losses. Form 8582 tracks it, along with Form 8949, Schedule D, Form 4797 and Form 6252 for the sale itself.

Sources

• IRS Publication 925, Passive Activity and At-Risk Rules (2025): Dispositions (Installment sale of an entire interest, Partners and S corporation shareholders, Dispositions by gift, Dispositions by death, Partial disposition of an activity); How To Report Your Passive Activity Loss; Identification of Disallowed Passive Activity Deductions; Carryover of Disallowed Deductions; Passive Activity Income (Disposition of property interests); Rental of Nondepreciable Property. Read November 2, 2026.

Edition read: Publication 925 (2025), for use in preparing 2025 returns. Dollar limits and dates in this publication are for 2025; check the current publication and form instructions for your tax year. This page summarizes the publication and does not replace it.