Suspended passive losses and an installment sale
The losses come out year by year. How the gain and the 469(g)(3) fraction work together, Pub. 925's example and a five-year table.
By Hans Goldstein, Enrolled Agent, admitted to practice before the IRS ·
The rule
When you sell your entire interest in a passive activity on the installment method, the sale still counts as a fully taxable disposition, but the release is spread.
IRC 469(g)(3) says paragraph (1) "shall apply to the portion of such losses for each taxable year which bears the same ratio to all such losses as the gain recognized on such sale during such taxable year bears to the gross profit from such sale (realized or to be realized when payment is completed)."
Pub. 925 and the Form 8582 instructions turn that into a recipe: multiply your overall loss (not counting losses allowed in earlier years) by a fraction. The numerator is the gain recognized this year. The denominator is the gain not yet recognized at the start of the year.
Pub. 925's example: a total gain of $10,000 reported at $2,000 a year frees 20% ($2,000 of $10,000) of the losses in year one and 25% ($2,000 of $8,000) of what is left in year two.
"Overall loss" has a meaning. The Form 8582 instructions say to combine all income and losses of the activity for the year, including prior-year unallowed losses. The gain you recognize this year is income of the activity, so it absorbs losses first, as passive income always does.
Reading A, below, applies the fraction to the overall loss that remains. The statute and Pub. 925's example word the ratio against "all such losses" without netting the year's gain first, which is Reading B. The total released over the note is the same, and the timing differs.
The table follows the form instructions because that is the form you file; ask your preparer which method the return uses.
Ray's five-year note
Ray sells his whole rental to an unrelated buyer for a note paid over five years. His total gain is $1,000,000, reported at $200,000 a year, and he has $900,000 of suspended losses.
| Year | Gain recognized | Losses at start of year | Absorbed by the year's gain | Overall loss left | Fraction | Released by the fraction | Total allowed | Still suspended |
|---|---|---|---|---|---|---|---|---|
| 1 | $200,000 | $900,000 | $200,000 | $700,000 | 20% | $140,000 | $340,000 | $560,000 |
| 2 | $200,000 | $560,000 | $200,000 | $360,000 | 25% | $90,000 | $290,000 | $270,000 |
| 3 | $200,000 | $270,000 | $200,000 | $70,000 | 33.3% | $23,333 | $223,333 | $46,667 |
| 4 | $200,000 | $46,667 | $46,667 | $0 | n/a | $0 | $46,667 | $0 |
Reading B, the literal ratio, frees 20% of all $900,000 in year one ($180,000) and lets the $200,000 of gain absorb part of the rest, so the totals allowed are $380,000, $330,000 and $190,000 in years one to three and nothing is left after year three.
By the end of year four every dollar is out under Reading A, and year five's gain has no losses left to absorb. If Ray's losses were $300,000 instead, year one's gain would absorb $200,000, the fraction (20%) would free $20,000 of the $100,000 left, and year two's gain would absorb the rest.
When the losses are small compared with the gain, the installment note changes little; when they are large, it spreads the release.
Each year, the allowed loss reduces ordinary income first and the gain is taxed at its own rate, the same swap shown on the allowed-versus-rate page. The amounts above are federal timing of the deduction, not tax saved.
Three things that change the pattern
- Recapture up front. Recapture income, meaning the amount that would be ordinary income under section 1245 or 1250 if all payments were received in the year of sale, is recognized in the year of sale even when no payment arrives (IRC 453(i)). That is mostly cost segregation and bonus-depreciated components. Straight-line building depreciation (unrecaptured section 1250 gain) is not recapture income and is not accelerated. A larger year-one gain means more is absorbed and more is released. See the depreciation recapture calculator.
- Losses on properties you keep. Each year's gain from the sold activity is passive income. It can absorb passive losses from other properties you still own. A cash sale gives you one year of that passive income. A note gives you one per year.
- Interest is different. Interest on the note is portfolio income, taxed as ordinary income, and cannot use passive losses.
Where installment sales do not release losses
- The buyer is related to you (IRC 469(g)(1)(B)). See related-party installment sales.
- You sell only part of your interest, or keep a retained piece of the activity.
- You sell one property out of an activity you grouped with others.
Large notes have their own rules: the section 453A interest charge applies to notes over $5 million, and Form 6252 reports each year's gain. If you would rather release everything now, you can elect out of the installment method. For rental property sold on the installment method, see installment sale of rental property.
Sources and dates
- 26 USC 469(g)(3) and (g)(1)(B); 26 USC 453(d) and (i).
- IRS Publication 925 (2025), Passive Activity and At-Risk Rules, "Installment sale of an entire interest"; 2025 Instructions for Form 8582, "Disposition of an Entire Interest."
- Temp. Reg. 1.469-2T(c)(2)(i) and (c)(3).
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
How are suspended passive losses released on an installment sale?
Two things happen each year. The gain you recognize is passive income of the activity, so it absorbs the activity's suspended losses first. Then the fraction in IRC 469(g)(3), the gain recognized this year over the gain not yet recognized at the start of the year, frees a share of the losses as non-passive.
The Form 8582 instructions apply the fraction to the overall loss left after the year's gain; the statute words it against all remaining losses. Everything allowed comes off other income as an ordinary deduction while the gain is taxed at its own rate.
Does the whole suspended loss come out in year one if I take a down payment?
Only the part the year's gain absorbs plus the fraction of the rest. With a large pile of losses and a small down payment, most of the pile stays suspended for later years. With losses smaller than the year's gain, the gain absorbs all of them.
Is it better to take the losses all at once?
It depends on your income each year. The release lands on ordinary income first, so it is worth the most in years when you have a lot of it. An installment sale also keeps passive income coming each year, which can absorb new losses from properties you keep. A cash sale releases everything at once and puts all the gain in one year. Run both.
Is the gain in later years still passive income?
Generally yes, if the property was used in a passive activity in the year of sale. Gain taken into account in later years on the installment method follows the character at the time of sale (Temp. Reg. 1.469-2T(c)(2)(i), Example 2). Interest on the note is portfolio income, not passive income, and cannot use passive losses (Temp. Reg. 1.469-2T(c)(3)).
What if I sell on the installment method to my son?
Then the sale is to a related person and no losses are released until he sells to an unrelated buyer in a fully taxable transaction (IRC 469(g)(1)(B)). Other related-party installment rules apply too. See the related-party page.
Can I elect out of the installment method to release everything now?
Yes. An election out under IRC 453(d) makes the entire gain taxable in the year of sale, which is then a fully taxable disposition, and all the suspended losses are released that year. You give up the deferral of the gain. See the page on electing out.
Related
- Suspended passive losses: the complete guide
- Do passive losses offset capital gains?
- Suspended losses and a 1031 exchange
- Passive loss carryover
- All passive loss guides
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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.