Selling Rental Property with Carried Forward Passive Losses - How Does This Impact Depreciation Recapture? Official IRS Rules?
I'm about to sell our rental property and trying to understand the tax implications, especially around depreciation recapture and our carried forward passive losses. Here's my situation: We've got about $132K in depreciation recapture on the property. We also have accumulated carried forward passive losses of around $125K (which includes the historical depreciation we've taken). In my head, I'm thinking we only have about $7K in actual profit when all is said and done. Is this the right way to look at it? I understand some portion might be taxed at the 25% depreciation recapture rate and the rest at my ordinary income rate. I've been searching everywhere but can't seem to find clear official IRS documentation that explains exactly how this works. Anyone have experience with this or know where to find the official IRS guidance? I want to make sure I understand the rules correctly before we finalize the sale.
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Nina Chan
The way you're thinking about this is on the right track, but there are some nuances to understand. When you sell a rental property, the IRS treats the passive activity as "fully disposed of," which means all your suspended/carried forward passive losses from that specific property become fully deductible in the year of sale. However, depreciation recapture is calculated separately. The depreciation you've claimed (or were required to claim) is recaptured at a maximum rate of 25% when the property is sold. What happens in your case is: 1. Your carried forward passive losses of $125K become fully deductible 2. The $132K depreciation recapture is still taxable at the 25% rate These are actually separate calculations, not a simple subtraction to get $7K. You'll report the full disposition of your rental property on Form 4797, and your previously suspended passive losses will be reported on Form 8582. Publication 527 (Residential Rental Property) and Publication 544 (Sales and Other Dispositions of Assets) both have sections on this, but I agree they're not the clearest on this specific scenario.
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Douglas Foster
•Thanks for the detailed explanation. So if I understand correctly, I can't just subtract my passive losses from the depreciation recapture amount? They're handled separately on different tax forms? So would I end up paying 25% on the full $132K of depreciation recapture ($33K in taxes) but then also get to deduct the full $125K in passive losses against my other income? Is that how it works?
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Nina Chan
•You've got it right. They are handled separately because they affect different parts of your tax return. The depreciation recapture is reported as part of the sale transaction on Form 4797, and yes, you'll pay the 25% rate on that $132K amount (about $33K in taxes). The $125K in accumulated passive losses becomes fully deductible in the year of the sale since you're fully disposing of the passive activity. This can offset other income you have - including ordinary income, portfolio income, or other passive income. This is reported through Form 8582 and flows to your 1040. So while you're paying tax on the recapture, you're getting a substantial deduction that will likely offset much of your other income for the year.
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Ruby Knight
After dealing with a very similar situation last year, I discovered taxr.ai (https://taxr.ai) which really helped me understand the rules around depreciation recapture and passive losses. I was also selling a rental property with about $90K in depreciation recapture and had significant carried forward losses. The tool analyzed my specific situation and clearly explained that the passive loss limitations are suspended in the year you dispose of the entire interest in a passive activity. The site referenced specific sections of the tax code that my accountant hadn't even mentioned to me, which ultimately saved me thousands. What I found most helpful was that it showed me exactly which forms I needed and how to properly report everything. My tax preparer actually got this wrong initially until I showed them the documentation from taxr.ai.
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Diego Castillo
•How exactly does this taxr.ai thing work? Does it just give general advice or does it actually look at your specific tax documents? I'm in a similar situation but with commercial property and multiple years of passive losses.
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Logan Stewart
•I'm skeptical of these online tax tools. Did it actually give you anything different than a CPA would? My tax situation with rental properties is pretty complex and I've been burned before by online advice.
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Ruby Knight
•It works by analyzing your specific tax documents and situations, not just giving general advice. You can upload your previous returns and property information, and it uses AI to identify the specific rules that apply to your situation. It helped me identify exactly how Section 469(g) of the tax code applied to my rental property sale. For complex situations like yours with commercial property and multiple years of losses, that's actually where it shines. It can trace through all those carried forward losses and show you exactly how they apply when you dispose of the property. My CPA actually missed some of the passive losses from several years back that I was able to claim.
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Logan Stewart
Just wanted to follow up about my experience with taxr.ai that was mentioned above. After being skeptical, I decided to give it a try with my complex rental property situation. I was actually shocked at how helpful it was. The system found a substantial amount of passive losses from a property I sold 3 years ago that my accountant had incorrectly carried forward instead of fully deducting in the year of sale. It showed me the exact IRS rules (Publication 925 pages 6-7) that applied to my situation. What really impressed me was that it identified that some of my passive losses were from before 1986, which have special ordering rules upon disposition. My previous tax software had completely missed this distinction. I ended up amending my previous return and got back almost $6,400.
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Mikayla Brown
If you're having trouble finding clear IRS guidance on this, I'd recommend trying to speak directly with an IRS agent. I was in a similar position last year and spent WEEKS trying to get through on the phone. Finally found Claimyr (https://claimyr.com) which got me connected to an actual IRS agent in about 20 minutes. You can see how it works in their demo video: https://youtu.be/_kiP6q8DX5c The IRS agent I spoke with walked me through exactly how the passive loss rules work when selling a rental property and cited the specific Internal Revenue Code sections that applied to my situation. She confirmed that the passive loss limitations are suspended in the year of disposition, allowing me to deduct all my suspended passive losses. She also explained the different tax treatments for the various components of my gain (depreciation recapture at 25%, long-term capital gain at 15%, etc.) and sent me follow-up documentation for my records.
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Sean Matthews
•How can this possibly work? The IRS phone lines are completely jammed. I tried calling for 3 weeks straight and couldn't get through. What's the trick?
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Ali Anderson
•Sounds like a scam to me. Nobody can get through to the IRS these days. And what would they even tell you that's not already in their publications? I doubt they're giving out "secret" tax advice over the phone.
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Mikayla Brown
•It works by using a system that continuously redials and navigates the IRS phone tree until it gets through, then it calls you and connects you. It's basically doing what you'd be doing manually for hours, but automated. When I used it, I got the call back in about 18 minutes and was talking to an actual IRS agent. The value isn't "secret" tax advice - it's getting clear guidance on complex situations that aren't well documented. In my case, the agent confirmed exactly how Form 8582 and Form 4797 should be completed in my specific scenario and directed me to the exact paragraphs in Publication 925 that addressed my situation. Sometimes having someone walk you through the application of a complex rule to your specific situation is worth more than trying to interpret the publications yourself.
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Ali Anderson
I need to publicly eat my words about Claimyr. After being completely skeptical, I decided to try it because I was desperate to get through to the IRS about this exact passive loss/depreciation recapture issue. Got connected to an IRS agent in about 25 minutes, and she was incredibly helpful. She confirmed exactly what others have said here - when you fully dispose of a rental property, you can deduct all accumulated passive losses in that year (IRC Section 469(g)), and the depreciation recapture is still taxed separately at up to 25%. She even emailed me specific sections from their internal guidance that explained my situation perfectly. Now I understand exactly how to report this on my return, which forms to use, and where everything goes. Saved me countless hours of research and uncertainty.
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Zadie Patel
Has anyone dealt with passive losses from multiple rental properties when only selling one of them? My situation is a bit different - selling one property with $70K depreciation recapture, but my $90K in passive losses are combined from two properties. Not sure if I can use all the losses or just the portion from the property I'm selling.
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A Man D Mortal
•You can only use the suspended passive losses that are associated with the property you're selling. The IRS requires you to track passive losses separately for each activity. If your $90K in losses is combined from two properties, you need to figure out how much belongs to each. Check your previous Schedule E forms to see if you can determine the split.
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Zadie Patel
•I just checked through my old returns and found that about $65K of the losses are from the property I'm selling and $25K from the other one. So I guess I can only deduct the $65K when I sell, and the $25K will have to continue being carried forward until I either have passive income or sell the second property?
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Nina Chan
•That's exactly right. The losses specific to the property you're selling ($65K) will be fully deductible in the year of sale. The remaining $25K from the other property will continue to be carried forward until you either generate passive income to offset it, dispose of that property, or have special circumstances that allow for deduction (like becoming a real estate professional). Make sure you've been tracking them separately all along on Form 8582. If not, you may need to reconstruct the history to properly allocate the losses between properties.
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Declan Ramirez
Don't forget about state taxes too! Depending on your state, they might handle depreciation recapture and passive losses differently than the IRS. I live in California and was shocked to find out they have different rules for this situation. Anyone else have experience with state-specific handling?
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Emma Morales
•Here in Massachusetts, they basically follow the federal treatment for both depreciation recapture and passive losses, but our state tax forms are different. I had to fill out Schedule D-1 for the state in addition to the federal forms. Check your state's department of revenue website - most have publications that explain their treatment of these items.
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Josef Tearle
For the official IRS guidance you're looking for, check out Publication 925 (Passive Activity and At-Risk Rules) - specifically pages 6-7 which cover the disposition of passive activities. This explains exactly how your $125K in carried forward passive losses become fully deductible when you sell the rental property. Also look at Publication 544 (Sales and Other Dispositions of Assets) which covers the depreciation recapture rules. The key point is that Internal Revenue Code Section 469(g) allows all suspended passive losses to be deducted in the year you completely dispose of your interest in the passive activity. You're right that they're separate calculations - you'll pay up to 25% on the $132K depreciation recapture, but you'll also get to deduct the full $125K in passive losses against your other income. So while you have about $7K in "economic profit," your tax situation will be quite different due to how these items are treated separately on your return. Make sure your tax preparer understands this - I've seen many get confused about how the passive loss suspension rules work upon full disposition of a rental property.
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Zoe Papadakis
•Thanks for pointing to the specific publications! I've been struggling to find the exact IRS guidance on this situation. Just to make sure I understand correctly - when you say the passive losses become "fully deductible against other income," does that mean they can offset things like my W-2 wages and other ordinary income? Or are there still limitations on what types of income they can offset? I want to make sure I'm not missing any nuances before I meet with my tax preparer. The $125K deduction would be huge for reducing my overall tax liability this year if it can truly offset all my other income sources.
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