Suspended passive losses at death, and when you give the property away
At death the step-up can use up the losses. A gift moves them into basis. The rule, Pub. 925's example and Ray's table.
By Hans Goldstein, Enrolled Agent, admitted to practice before the IRS ·
Death: the excess-over-step-up rule
IRC 469(g)(2) treats a transfer at death differently from a sale. The decedent's suspended losses are released only to the extent they are greater than the excess of the transferee's basis over the decedent's adjusted basis just before death. In other words, the step-up in basis under IRC 1014 uses up the losses first. Whatever the step-up covers is not deductible by anyone.
Pub. 925's example: the heir's basis rises by $6,000 and unused losses were $8,000, so the decedent's final return gets a $2,000 deduction ($8,000 minus $6,000).
| Fair market value at death | Step-up | Losses allowed on the final return | Losses lost |
|---|---|---|---|
| $1,500,000 | $900,000 | $0 | $300,000 |
| $900,000 | $300,000 | $0 | $300,000 |
| $700,000 | $100,000 | $200,000 | $100,000 |
| $550,000 | None (value is below basis) | $300,000 | $0 |
The last row shows the other side of the rule: if the property is worth no more than its basis there is no step-up to consume the losses, and they are allowed in full on the final return. Where community property rules give the surviving spouse a new basis on the whole property, the step-up is larger and the losses are used up faster.
Gift: the losses move into basis
If Ray gives his interest away, the suspended losses are not deducted in any year. Under IRC 469(j)(6), the basis of the interest immediately before the transfer is increased by the losses, and the losses are never allowed. In Ray's case, a $600,000 basis becomes $900,000 before the gift.
The donee's basis for computing gain is that carryover amount; for computing a loss it can be no higher than fair market value at the time of the gift.
That is useful if the donee will sell at a gain, because the higher basis lowers it. It is not a deduction for Ray, and there is no rate swap.
What this means for planning
- Hold and the losses may disappear. For an owner who plans to hold until death, the losses are mostly a paper balance that never pays off. That changes the value of a sale during life.
- Sell and they become a deduction. The release in a taxable sale is the only way to use the whole balance against salary and other ordinary income. Compare it against the step-up, which can erase the gain and the recapture.
- Gift and they become basis. Useful for a donee who will sell, worthless for the donor's own return.
- Estate size. If the estate may owe tax, the comparison widens. See buy, borrow, die versus a 1031 plus installment sale plus ILIT.
Back to the complete guide to suspended losses.
Sources and dates
- 26 USC 469(g)(2), (i)(4), (j)(6), (j)(12); 26 USC 1014.
- IRS Publication 925 (2025), Passive Activity and At-Risk Rules, "Dispositions by gift" and "Dispositions by death."
Checked against the sources above on October 30, 2026. Dollar figures are 2026 federal (Rev. Proc. 2025-32) unless the page says otherwise. Education only, not tax or legal advice for your situation.
Questions
What happens to suspended passive losses when the owner dies?
They are allowed on the decedent's final return only to the extent they exceed the step-up in basis the heirs receive (IRC 469(g)(2)). When the property has appreciated by more than the losses, the step-up consumes all of them; for property with little appreciation, part or all of the losses can still be deducted.
Do my heirs inherit my suspended losses?
No. The heirs take a new basis under IRC 1014. They do not receive the decedent's suspended losses. Any part not allowed on the final return is not allowed to anyone.
What happens if I give the property to my child?
The suspended losses are never deducted. Instead the basis of the gifted interest is increased by the amount of the losses (IRC 469(j)(6)), which raises the donee's carryover basis for computing gain. The donee's basis for computing a loss is still limited by fair market value.
Is a sale during life better than holding until death?
For the suspended losses alone, yes: a qualifying sale turns the whole balance into an ordinary deduction, and death may erase most of it. But holding gets the step-up, which can wipe out the gain and the depreciation recapture, so it is rarely decided on the losses alone.
Does the estate get the $25,000 allowance?
An estate, for taxable years ending less than two years after the date of death, can use the $25,000 special allowance for rental real estate in which the decedent actively participated, reduced by the allowance the surviving spouse uses (IRC 469(i)(4)).
What about an estate or trust distributing the interest?
When an estate or trust distributes an interest in a passive activity, the basis is increased by the losses allocable to the interest, and the losses are not allowed as deductions (IRC 469(j)(12)).
Related
- Suspended passive losses: the complete guide
- Passive loss carryover
- Suspended losses and a 1031 exchange
- Section 469 passive activity rules
- All passive loss guides
Run my numbers with Hans: book a scope call
Hans Goldstein is an Enrolled Agent, admitted to practice before the Internal Revenue Service. Not affiliated with or endorsed by the IRS. He is not a CPA or attorney. Education only, not tax or legal advice for your situation.