Suspended Passive Losses When You Sell a Rental (2026)

The three-part test

The losses free up in full only when all three are true (IRC 469(g)(1)(A)):

You dispose of your entire interest in the activity, not a share of it.
The sale is fully taxable: no 1031, no gift.
The buyer is unrelated to you under the related-party rules.

What the freed losses are worth

Assumptions (illustration only): married couple filing jointly in Texas, $150,000 of other ordinary income. They sell a rental for $900,000 with an adjusted basis of $500,000, a $400,000 gain: $150,000 of unrecaptured Section 1250 gain and $250,000 of long-term gain. Their Form 8582 shows $120,000 of suspended losses on this property.

Fully taxable cash sale in 2026. The freed losses come off the bottom of the income stack, so they also pull part of the gain into lower brackets.
	Without freed losses	With $120,000 freed
Gain on the sale	$400,000	$400,000
Other ordinary income	$150,000	$150,000, less $120,000 of freed losses
Tax on the 25% recapture slice	$34,128	$21,940
3.8% NIIT	$11,400	$6,840
Federal income tax added	$71,628	$44,100
Total federal tax added by the sale	$83,028	$50,940
Saved by the freed losses		$32,088

Tax figures are the federal income tax (including any alternative minimum tax) and 3.8% net investment income tax added by the sale, from the Big Sale Tax engine, standard deduction applied, with 2026 federal brackets (IRS Rev. Proc. 2025-32) held flat for every payment year. Later brackets are indexed for inflation, so later years are shown conservatively. Payout rate 6% is an illustration, not a quote.

"Suspended losses cannot offset recapture" is wrong

You will see this claim online, including in some AI answers. Once a qualifying sale frees the losses, they are no longer passive. They are ordinary deductions against any income: wages, interest, the long-term gain and the recaptured depreciation alike. There is no bucket that walls off recapture.

In the table, the freed losses cut the tax on the 25% slice from $34,128 to $21,940, because they come off the bottom of the income stack and pull that slice into a lower bracket.

Cash, 1031, structured installment sale, or 1031 + structured sale

How you sell decides when the losses work. Same rental and losses, four paths:

Same rental, four ways. A negative first-year figure means the released losses cut tax on other income by more than the gain added.
	Cash sale	1031 exchange	Structured installment sale, 10 years	1031 + structured sale on $200,000 of boot
Losses used	All $120,000 in the year of sale	None; all $120,000 stay suspended	All $120,000, released in years 1 to 4	$120,000 against the boot gain as it arrives; $0 left suspended
Federal tax on the gain, with the losses	$50,940	$0 now; $400,000 of gain deferred	$44,101	$14,100; $200,000 deferred
Same path without the losses	$83,028	$0 now	$70,501	$40,499
Value of the losses on this path	$32,088	$0 now (they wait)	$26,400	$26,399
First-year tax on the gain	$50,940	$0	-$1,496	$0
What you receive	$849,060 after tax	A property	$122,281 a year for 10 years	A $700,000 property plus $27,174 a year
Interest in the payments, and its tax	None	None	$322,812, taxed $71,019	$71,737, taxed $15,782

Why the 1031 column shows no saving. A 1031 is not fully taxable, so IRC 469(g) does not free the losses. They are not lost; they keep waiting and can offset future passive income, and they free up when you finally sell in a fully taxable sale.

Why the combined column works. Boot gain from selling a rental is passive income (Temp. Treas. Reg. 1.469-2T(c)(2)), and suspended passive losses can always offset passive income. Taking the $200,000 of boot as a structured installment sale lets the losses absorb it year by year, so the boot costs $14,100 instead of $40,499.

Installment and structured sales: losses come out in step

In an installment sale, each year's gain is passive income, so the losses absorb it first. Then a share of the rest is released, in the ratio of that year's gain to the gain still to come (IRC 469(g)(3)). In this example the losses are used up in year 4.

10-year structured installment sale of the same rental, 6% illustrative payout rate, $120,000 of suspended losses.
Year	Gain reported	Of which 25% slice	Losses used	Tax on gain
1	$30,347	$30,347	$37,149	-$1,496
2	$32,168	$32,168	$36,579	-$970
3	$34,098	$34,098	$35,328	-$271
4	$36,144	$36,144	$10,944	$5,544
5	$38,313	$17,243	$0	$6,954
6	$40,611	$0	$0	$6,092
7	$43,048	$0	$0	$6,457
8	$45,631	$0	$0	$6,845
9	$48,369	$0	$0	$7,255
10	$51,271	$0	$0	$7,691
Total	$400,000	$150,000	$120,000	$44,101

Which sales free the losses

Sale type	Losses freed?	Rule
Cash sale of the whole property to an unrelated buyer	All, in the year of sale	IRC 469(g)(1)(A)
Installment sale, including a structured installment sale	In step with the gain: each year's gain absorbs losses, and a pro rata share of the rest is released	IRC 469(g)(3)
Sale to a related party	No. They stay suspended until the related buyer sells to an unrelated party	IRC 469(g)(1)(B)
1031 exchange	No (not fully taxable). Recognized boot is passive income, so the losses can absorb it	IRC 469(g), Temp. Treas. Reg. 1.469-2T(c)(2)
Death	Freed, reduced by the step-up in basis	IRC 469(g)(2)
Gift	Not freed; added to the recipient's basis	IRC 469(j)(6)

Where to find your number

Last year's return: Form 8582 and its worksheets show the prior-year unallowed loss for each activity.
Year of sale: the sale goes on Form 4797, and the freed losses run through Form 8582 for that activity.
Installment sale: Form 6252 reports each year's gain, and the release follows it. See Form 6252.

Gray areas: competing positions

Careful practitioners argue these points both ways. We show both sides; we do not pick one for you.

Grouped rentals

Position A. If your returns grouped several rentals as one activity (Treas. Reg. 1.469-4), selling one building is not a disposition of your entire interest, so its losses stay suspended.
Position B. Some practitioners treat a sale of substantially all of a grouped activity as enough to free the losses.

What both sides agree on: Check how the returns grouped the rentals before relying on a release.

NIIT on the freed losses

Position A. Losses allowed on the disposition are deductions properly allocable to rental income and reduce net investment income that year (Treas. Reg. 1.1411-4). Our table uses this view.
Position B. Losses from years when the rental was not a passive activity for NIIT purposes, for example while you qualified as a real estate professional, may be treated differently.

What both sides agree on: The regular income tax saving does not depend on this question; only the 3.8% piece does.

Real estate professional status

Position A. If you qualified (IRC 469(c)(7)), some or all of the rental losses were never suspended, so there is less to free on the sale.
Position B. The hours behind that status are among the most examined facts in a rental audit. If the status is denied, losses you deducted become suspended again.

What both sides agree on: Keep hour logs, and know which years claimed the status before you count the losses.

Suspended losses after a 1031

Position A. The losses stay with the activity and continue into the replacement property; they free up when the replacement is sold in a fully taxable sale.
Position B. Some read 469(g) as tied to the original property and argue for tracking the losses separately from the replacement.

What both sides agree on: A 1031 does not free them, and they can always offset passive income, including recognized boot.

Frequently asked questions

Can suspended passive losses offset depreciation recapture?

Yes. Once a qualifying sale frees them, they offset any income, recapture included (IRC 469(g)).

Do I lose suspended losses if I do a 1031 exchange?

No. They stay suspended and keep waiting. They can offset passive income, including any boot gain, and they free up in full when you later sell in a fully taxable sale.

What if I sell the rental at a loss?

If the three-part test is met, the loss on the sale and the suspended losses are both deductible that year.

Does an installment sale delay my suspended losses?

Partly. Each year's gain absorbs losses, and the rest is released in proportion to the gain reported (IRC 469(g)(3)). In our 10-year example they were used up by year 4.

What if I sell the rental to my son?

A sale to a related party does not free the losses. They stay suspended until your son sells to an unrelated buyer (IRC 469(g)(1)(B)).

Are suspended passive losses lost at death?

They are freed at death, but only to the extent they exceed the step-up in basis the heirs receive (IRC 469(g)(2)).

Sources

Links checked October 26, 2026.

Hans Goldstein is an Enrolled Agent, admitted to practice before the Internal Revenue Service. Not affiliated with or endorsed by the IRS. General education, not tax or legal advice for your situation.

Insurance products offered through Goldstein & Co. LLC dba Goldstein Insurance Services, CA license 4273294. If you implement a structured installment sale through that business, Hans is paid a commission by the insurer; it is built into the payout rate. See the disclosures.

Also free: the book Same Sale, Different Tax, the same $1,000,000 gain taxed ten ways. Want it run on your sale? Book a free scope call to see whether the Big Sale Tax Analysis is worth it.

Who you will talk to

Hans Goldstein · Sacramento, California
Hans Goldstein: Tax & Exit Planning, an independent practice. Enrolled Agent, admitted to practice before the Internal Revenue Service. CA Insurance License #4273294, NPN 20602398.

What happens first: You fill in the short form for a free scope call, about 5 minutes. Hans reviews every one personally and replies within 1 business day. If it is a fit, you get a link to book the call.
The scope call: Fifteen minutes, free: price, timeline, what you are selling and what the money is for. Scope means you hear whether the analysis is worth it for your sale.
What you get: A written side-by-side comparison of your cash-sale baseline against every path that fits, year-by-year numbers, a written recommendation, and a review meeting with you and, if you like, your CPA and attorney.
What it costs: The scope call is free. The Big Sale Tax Analysis is $5,000 per household per transaction, only if you decide it is worth it. No retainer, no hourly billing, no obligation to use any strategy.
How Hans is paid: The $5,000 fee pays for analysis only and is not reduced or credited if you buy anything. You are never required to buy anything. No referral fees are paid to or received from brokers, CPAs or attorneys. Hans is also a licensed insurance producer with a separately owned insurance business. That business is not part of this engagement, and the analysis does not recommend insurance products. If you later choose an installment sale funded through an insurance company, that company pays Hans a commission through his separate insurance business. He may be compensated by that business if you use an insurance-funded installment sale. Hans is an Enrolled Agent (EA), admitted to practice before the Internal Revenue Service. He is not a CPA, attorney or registered investment adviser; the analysis models tax effects and does not recommend specific securities. Read the disclosures.

Book a free scope call or call 213-340-2018. Hans answers or calls back the same business day.

Suspended passive losses when you sell a rental: when they free up and what they save (2026)