10.13 Suspended Losses Allowed on Disposition of Your Interest
Losses and credits that may not be claimed in one year because of the passive activity limitations are suspended and carried forward to later years. The carryover lasts indefinitely, until you have passive income against which to claim the losses and credits. No carryback is allowed. What if you have suspended losses and later materially participate in the business in which the loss was realized? The losses remain passive losses but since you now materially participate, the suspended losses may offset nonpassive income of that activity.
Caution
Allocation of suspended loss.
If your suspended loss is incurred from several activities, you allocate the loss among the activities using the worksheets accompanying Form 8582. The loss is allocated among the activities in proportion to the total loss. If you have net income from significant participation activities (see Test 4 (10.6)), such activities may be treated as one single activity in making the allocation; see the instructions to Form 8582.
| Sales price | $50,000 | |
| Less: Adjusted basis | $42,000 | |
| Gain | $8,000 | |
| Less: Current year loss | $3,000 | |
| Suspended losses | $2,000 | $5,000 |
| Overall gain | $3,000 |
Disposition of a passive interest.
A fully taxable sale of your entire interest to a nonrelated person will allow you to claim suspended deductions from the activity. Worthlessness of a security in a passive activity is treated as a disposition. An abandonment also releases suspended losses.
On a disposition, the suspended losses plus any current year income or loss from the activity are combined with the gain or loss from the disposition; see the Examples below and follow the instructions to Form 8582 for reporting the net gain or loss.
Partial disposition.
You may for the taxable year in which there is a disposition of substantially all of an activity treat the part disposed of as a separate activity. You must show: (1) the amount of prior year suspended deductions and credits allocable to that part of the activity for the taxable year, and (2) the amount of gross income and any other deductions and credits allocable to that part of the activity for the taxable year.
Caution
Gifts.
When a passive activity interest is given away, you may not deduct suspended passive losses. The donee’s basis in the property is increased by the suspended loss if he or she sells the property at a gain. If a loss is realized by the donee on a sale of the interest, the donee’s basis may not exceed fair market value of the gift at the time of the donation.
Death.
On the death of an investor in a passive interest, suspended losses are deductible on the decedent’s final tax return, to the extent the suspended loss exceeds the amount by which the basis of the interest in the hands of the heir is increased.
Installment sales.
If you sell your entire interest in a passive activity at a profit on the installment basis, suspended losses are deducted over the installment period in the same ratio as the gain recognized each year bears to the gain remaining to be recognized as of the start of the year. For example, if you realize a gain of $10,000 and report $2,000 of gain each year for five years, in the year of sale you report 20% of your total gain under the installment method, and 20% of your suspended losses are also allowed. In the second year, you report $2,000 of the remaining $8,000 gain and 25% of the remaining losses ($2,000 ÷ $8,000) are allowed.
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