Many Taxpayers are now finding themselves in situations where they have suspended passive losses from one or more passive activities. A passive activity is any business activity in which the taxpayer did not materially participate, as well as any rental activity. Limited partners are generally treated as not having materially participated in the partnership. Many taxpayers with rental properties have been unable to benefit from the losses generated by the properties due to the $25,000 loss limitation and the phase-out rules for adjusted gross income over $100,000. Also, many taxpayers with partnership interests have accumulated suspended passive losses, which generally can only be used to offset passive income. Suspended passive losses can be utilized if the passive activity that generated them is sold in fully taxable transaction, or to the extent a taxpayer has passive income.
The gain from the sale of a passive activity is generally reported and taxed as a capital gain through form 4797 and Schedule D. The gain is also considered passive income on the passive activity worksheets. The sale of a passive activity in a fully taxable transaction triggers the release of any suspended losses associated with that activity. However, if the passive activity is sold for a gain, and the gain exceeds the suspended loss associated with that particular activity, the gain will trigger the release of other suspended losses from unrelated passive activities. Given a large enough gain on the sale of a rental property, all suspended losses from all of a taxpayer’s unrelated passive activities may be released for use against current income.