Passive Activity Loss
A loss from a business or rental activity in which you do not materially participate. Passive losses can generally only be deducted against passive income, not wages or portfolio income.
Passive activity loss (PAL) rules under IRC Section 469 limit the deductibility of losses from business or rental activities in which the taxpayer does not materially participate. A passive activity is generally any trade or business where the taxpayer does not participate in operations on a regular, continuous, and substantial basis — typically defined as more than 500 hours per year.
Passive losses can only be used to offset passive income from other passive activities. They cannot be deducted against wages, salaries, or portfolio income (interest and dividends). Disallowed passive losses are suspended and carried forward to future years, where they can be applied against future passive income or released entirely when the activity is sold in a fully taxable transaction.
Rental activities are automatically classified as passive regardless of the owner's participation, with two important exceptions. Real estate professionals who spend more than 750 hours per year in real property trades and more than half their working time in real estate can treat rental activities as non-passive. Additionally, active participants in rental real estate with modified AGI under $100,000 can deduct up to $25,000 in rental losses annually against non-passive income, with the allowance phasing out between $100,000 and $150,000 of modified AGI.
How it works
Passive activity loss rules under IRC Section 469 limit how you can use losses from a business or rental activity you don't materially participate in — generally meaning you're not involved on a regular, continuous, and substantial basis, with more than 500 hours a year being the usual benchmark for material participation. A loss from a passive activity can only offset income from other passive activities; it can't be used against wages or portfolio income like interest and dividends.
You track this on Form 8582, and any passive loss you can't use in the current year because you don't have enough passive income to absorb it doesn't disappear — it's suspended and carried forward, available against future passive income or fully released when you sell the activity in a taxable transaction. Rental real estate is automatically treated as passive no matter how involved the owner is, with two exceptions built into the rules.
A real estate professional who spends more than 750 hours a year in real property trades, and more than half of their total working time there, can treat rental activities as non-passive. Short of that, an active participant in rental real estate with modified AGI under $100,000 can deduct up to $25,000 of rental losses against non-passive income like wages each year, with that $25,000 allowance phasing out as MAGI rises from $100,000 to $150,000.
Example: the $25,000 active-participant allowance and its phase-out
A taxpayer with modified AGI of $90,000 actively manages a rental property that generates a $30,000 loss for the year. Because their MAGI is under $100,000, they can deduct the full $25,000 allowance against their wages, and the remaining $5,000 suspends and carries forward to a future year.
Now compare a taxpayer with MAGI of $120,000 — 40% of the way through the $100,000-to-$150,000 phase-out range. Their $25,000 allowance is reduced proportionally by that 40%, leaving roughly $15,000 they can deduct against non-passive income this year, with the rest suspended.
Frequently asked questions
Can I deduct a rental property loss against my regular wages?
What does 'material participation' mean for passive activity loss rules?
What happens to a passive loss I can't deduct this year?
Related Terms
Rental Income
Money received for the use of property you own, including rent payments, advance rent, and security deposits applied to rent. Rental income is generally taxable and reported on Schedule E.
Net Investment Income Tax (NIIT)
A 3.8% surtax on the lesser of net investment income or modified AGI exceeding $200,000 (single) or $250,000 (married filing jointly). Applies to interest, dividends, capital gains, and rental income.
Net Investment Income Tax (NIIT)
A 3.8% surtax on investment income (interest, dividends, capital gains, rental income) for individuals with modified AGI above $200,000 (single) or $250,000 (married filing jointly).
Adjusted Gross Income (AGI)
Your gross income minus specific adjustments such as student loan interest, IRA contributions, and self-employment tax. AGI is the starting point for calculating your taxable income.