Freeing Suspended Passive Losses — and the New 2026 Trap
Say you bought a rental property for $ 300,000 ten years ago. Depreciation and expenses have created a loss on paper almost every year since. You can’t use most of it, because your other income is too high to qualify for the usual $ 25,000 write-off. So the loss just sits there, year after year, tracked on a tax form but never actually lowering your tax bill.
This is what a “suspended passive loss” is. It’s real. The IRS has already agreed it’s a valid deduction. You just can’t use it yet.
There’s a way to unlock all of it at once: selling the property.
But 2 things have changed the math on that plan. First, a rule that used to expire has now been made permanent, and it can cap how much of your freed-up loss you get to use in the year you sell. Second, if you’re a foreign investor, a separate rule (FIRPTA) will grab 15% of your sale price at closing, whether you actually owe any tax. Unlike general guides aimed purely at domestic taxpayers, this article addresses the FIRPTA implications for non-U.S. investors.
Here’s how all of this fits together, with real numbers.
1. What Are Suspended Passive Losses?
The IRS treats almost all rental property as a “passive activity”, no matter how much work you personally put into it. Passive losses can only offset passive income. If your rental loses money on paper — which is common once depreciation is included — and you don’t have other passive income to soak it up, the loss doesn’t vanish. It gets suspended. It carries forward, year after year, tracked on IRS Form 8582.
There’s one exception: the $ 25,000 special allowance. If you actively manage your rental (you approve tenants, set the rent, sign off on repairs) you can deduct up to $ 25,000 of losses against your regular income each year. But this shrinks as your income rises. It starts phasing out at $ 100,000 of modified adjusted gross income (MAGI) and disappears completely at $ 150,000.
Say your MAGI is $130,000. That’s $30,000 over the $100,000 starting point. The rule cuts your allowance by 50 cents for every dollar over that line, so your $ 25,000 allowance drops by $ 15,000, leaving you with just $ 10,000 you can use. Go above $ 150,000, and the allowance disappears entirely.
This is exactly why many investors with careers or businesses alongside rental property end up with the allowance reduced to zero — and years of suspended losses stacking up, unused.
2. How Suspended Losses Actually Get Freed
There are two ways to use suspended losses. They work very differently:
Slow way; passive income offset: If you earn passive income, from this property or another one, your suspended losses can offset it, dollar for dollar, in that year. If you only have a small amount of passive income each year, clearing out a large backlog this way can take a decade or more.
Fast way; sell the whole thing: When you sell your entire interest in the property, in a real, taxable sale, to someone you’re not related to, every suspended loss tied to that property is released, all at once, against any income you have, not just passive income. This is the lever that actually matters for exit planning.
But there are two conditions you need to meet and missing either one means no release.
Condition 1: You sell the entire interest. Not part of it. If you sell 50% of a property and keep the other half, the release doesn’t happen.
Condition 2: The sale is taxable. A 1031 exchange doesn’t count here, even though it feels like a sale. With a 1031 exchange, you’re not paying tax on the sale. You’re rolling the gain into a new property instead. Because no tax event actually happens, your suspended losses don’t get released. Instead, they carry over and attach to the new property.
Miss either condition, and you don’t get the release. We regularly see investors sell a property expecting their losses to clear, only to find out later that the sale didn’t qualify — usually because of a 1031 exchange, or because they only sold part of their ownership stake.
3. The New 2026 Trap: The Excess Business Loss Limitation
Let’s say you own several rental properties, and your suspended losses add up to $ 400,000. You sell everything in one year, releasing all $ 400,000 at once. You’d expect this to wipe out most of your taxable income for that year.
But there’s a separate rule; the excess business loss limitation that caps how much of a business loss like this you can deduct against non-business income (wages, interest, capital gains from other sources) in a single year. The cap is adjusted for inflation each year; it’s roughly in the range of $ 300,000 for a single filer, higher for joint filers. Confirm the exact number for the current year with your CPA, since it moves annually.
In our example, $ 400,000 in freed-up losses against a roughly $300,000 cap means about $ 100,000 gets stuck. It isn’t lost; it converts into a net operating loss (NOL) that carries forward to future years. But it’s not the immediate, full tax relief you were expecting the year you sell.
This provision previously carried an expiration date, which is why much of the existing planning literature does not treat it as a permanent consideration. Recent legislation has made it permanent.
4. The FIRPTA Wrinkle for Foreign Investors
If you’re a foreign investor selling U.S. real estate, there’s a rule called FIRPTA.
The buyer must withhold 15% of your sale price and send it straight to the IRS. Not 15% of your profit. 15% of the total price you sold for. This happens automatically at closing, no matter what your actual tax bill turns out to be.
Let’s walk through an example:
- You sell your rental for $ 500,000.
- The buyer withholds 15% of that: $ 75,000. This goes to the IRS at closing.
- But your suspended losses mean your real tax bill on this sale is only $ 10,000.
- That leaves $ 65,000 of your own money sitting with the IRS — money that isn’t owed, but is being held anyway.
You do get this money back eventually. But only after you file your tax return and wait for your refund. That can take close to a year.
There’s a way to avoid this. Before closing, you can file Form 8288-B. This form tells the IRS: “Here’s my real expected tax bill, including my suspended losses” — and the IRS can approve a lower withholding amount that actually matches what you’ll owe.
The timing is strict, though. You must file this before the sale closes. If you file it after closing, it’s too late; the full 15% has already been withheld, and you’re back to waiting for a refund.
For an investor living abroad with large suspended losses, this step is often the most important part of the entire sale — sometimes even more important than the excess business loss issue covered earlier.
5. Practical Exit-Timing Considerations
A few things to check before you set a closing date:
Partial sales don’t release anything. Selling part of your interest, or restructuring ownership between related parties, doesn’t trigger the full release. You need a complete sale.
Installment sales spread the timing out. If you sell on an installment basis, gain recognition —and possibly your loss releas — gets spread across s
everal years instead of happening all at once. Depending on your income in each of those years, this can help you stay under the excess business loss cap, or it can work against you. Model it before choosing this route.
How your properties are grouped matters. If you own more than 1 rental, how they’re grouped for tax purposes affects whether selling one property releases only that property’s losses, or the whole group’s.
Real estate professional status is a different path entirely. If you or a spouse spends more than 750 hours a year on real estate —and more time on real estate than on anything else— your rental losses can become fully usable each year, bypassing the suspended-loss problem going forward. This is a high bar, and rarely realistic for someone with a full-time career abroad, but it exists.
The year you sell matters as much as the sale itself. Both the excess business loss cap and your FIRPTA withholding certificate depend on your total income in that specific year. Selling in a lower-income year —or timing other income around the sale— can change how much of your freed-up loss you actually get to use right away.
6. Common Mistakes That Cost More
- Assuming a 1031 exchange frees up suspended losses. It doesn’t. The losses carry over to the new property.
- Selling to a related party. This can disqualify the sale from counting as a full release.
- Skipping Form 8288-B. Wait until after closing, and the standard 15% withholding has already happened.
- Ignoring the excess business loss cap when picking a sale year. A large loss release can still get partly pushed into an NOL if it lands in a high-income year.
- Trying to handle all of this alone. Three separate federal rules — passive activity rules, the excess business loss limitation, and FIRPTA — interact in a single sale. Each has its own form, its own threshold, and its own deadline.
The Bottom Line
Suspended passive losses aren’t gone money. But freeing all of it requires a full sale; not a 1031 exchange, not a partial transfer. And two other rules can affect how much you walk away with: the excess business loss limitation may cap how much you can use right away, and FIRPTA will withhold 15% of your gross sale price at closing unless you’ve filed for a certificate in advance.
Each rule is manageable alone. Together, in one sale, they need to be planned before your closing date — not after.
Planning an exit from a rental property? Let’s model your exit timing together, before you set a closing date.
Sources
IRS Publication 925 (2025), Passive Activity and At-Risk Rules
IRS Publication 527 (2025), Residential Rental Property | $ 25,000 Special Allowance
IRS Form 461, Limitation on Business Losses | Excess Business Loss
