Passive Activity Loss Limitations for Physicians: Why Your Rental Losses Get Stuck (and How to Free Them)
Updated: 2 days ago
You bought a rental property. Your tax team ran depreciation, and on paper the property lost $30,000 last year. Then your return came back, and that $30,000 didn't touch your W-2 income at all. It sits on a form called 8582 with a label that sounds like a diagnosis: "suspended."
Those are the passive activity loss limitations at work. For most attending physicians, they are the main reason a rental loss doesn't lower this year's tax bill.
A suspended loss isn't a lost loss, though. It carries forward, and there are specific ways to put it to use, either in the year it happens or when you sell.
In This Blog
What is the $25,000 passive loss exclusion, and can physicians use it?
Worked example: Dr. Patel's long-term rental over five years
How do passive loss rules interact with basis, at-risk, and excess business loss limits?
Does the 3.8% net investment income tax apply to your rental income?
Physician traps: self-rental, the practice building, and state rules
What are the passive activity loss limitations?
The passive activity loss limitations are rules in Section 469 of the tax code that stop losses from passive activities, including most rentals, from offsetting your wages or practice income. A passive loss can only offset passive income, and whatever you can't use carries forward.
The IRS summarizes the rules in Tax Topic 425 and covers them in depth in Publication 925.
The rules sort your income into three buckets:
Nonpassive income: your W-2 wages, your 1099 or practice income, and any business you materially participate in.
Portfolio income: interest, dividends, and gains on investments.
Passive income and losses: businesses you own but don't materially participate in, plus rental activities.
Losses in the passive bucket can't cross over into the other two. So a $30,000 rental loss can't offset $30,000 of hospital wages, even though both show up on the same return.
What happens to the loss you can't use? Section 469(b) treats it as a deduction allocable to the same activity in the next taxable year.
It rolls forward, year after year, until you have passive income to absorb it or you sell the property in a qualifying sale. (26 U.S.C. 469)
Why is rental real estate passive for most physicians?
Most business activities are passive only if you don't materially participate. Rentals are different. Under Section 469(c)(2), a rental activity is passive by default, no matter how many hours you put into it.
You could spend every Saturday screening tenants and fixing a water heater, and the rental would still be passive. Hours alone don't change the label.
There are three main ways around that default:
The $25,000 special allowance for people who actively participate (with an income limit that shuts most physicians out).
Real estate professional status, which almost always runs through a nonphysician spouse.
A short-term rental with a short average guest stay, which the rules don't treat as a "rental activity" at all.
A fourth path, selling the property, releases whatever losses have piled up. We'll cover each one.
What is the $25,000 passive loss exclusion, and can physicians use it?
Sometimes, but usually not once you're an attending.
If you actively participate in a rental, Section 469(i) lets you deduct up to $25,000 of rental real estate losses against your other income. "Active participation" is a lower bar than material participation. Making management decisions, like approving tenants, setting rent, or signing off on repairs, generally counts.
You also need to clear an ownership test and an income test:
Ownership: you (together with your spouse) need at least a 10% interest by value. A limited partnership interest generally doesn't qualify.
Income: the $25,000 shrinks by 50% of your modified adjusted gross income (MAGI) above $100,000. At $150,000 it's gone.
Here's how the phase-out works at different incomes:
Modified AGI | Maximum allowance |
$100,000 or less | $25,000 |
$120,000 | $15,000 |
$140,000 | $5,000 |
$150,000 or more | $0 |
The MAGI used here isn't your regular AGI. It's figured without subtracting IRA deductions or student loan interest, without counting taxable Social Security, and without the passive losses themselves.
For physicians, two more details matter:
These numbers are not indexed for inflation. The $25,000, $100,000, and $150,000 amounts are written into the statute and haven't moved. The 2025 IRS instructions for Form 8582 still use them.
Married filing separately rarely helps. If you file separately, the allowance drops to $12,500 with a phase-out from $50,000 to $75,000, and only if you and your spouse lived apart the entire year. If you lived together at any point, there is no allowance at all.
Who can still use it? Residents, fellows, physicians working part time, and physicians in early retirement whose income has dropped below $150,000.
Example: Dr. Rivera, PGY-3
Modified AGI: $120,000
Allowance: $25,000 minus 50% of ($120,000 minus $100,000) = $15,000
Rental loss this year: $12,000
Deductible against salary: the full $12,000
This hypothetical is for illustration; your results will differ.
For Dr. Rivera, this is the year to keep good records. Once attending income arrives, the allowance disappears.
What happens to your suspended passive losses?
They wait. This passive activity loss carryover has no time limit, and each loss stays tied to the activity that produced it.
Each year, suspended losses are combined with your other passive losses and netted against income from all of your passive activities. If your rental turns profitable, or you own another passive investment that throws off income, the old losses absorb that income before you pay tax on it.
The carryforward lives on Form 8582 and its worksheets. The IRS says the form is filed by individuals who have passive activity deductions, "including prior year unallowed losses." (Instructions for Form 8582) Suspended losses can get lost when you switch preparers and the worksheets don't come along.
A simple habit: every year, confirm your return shows the prior-year unallowed loss for each property, and keep a copy of the Form 8582 worksheets with your permanent records.
How do you release suspended losses when you sell?
Selling your entire interest in the activity in a fully taxable sale frees the losses. Under Section 469(g)(1)(A), when you dispose of your entire interest and all gain or loss is recognized, the activity's losses are treated as not from a passive activity. At that point they can offset your wages and practice income.
Not every exit works the same way:
Selling to a related party: the losses stay suspended until the property is later sold to an unrelated buyer. Related parties include certain family members and entities you control.
Installment sale: the losses release gradually, in proportion to the gain you report each year.
Gift: the suspended losses are never deducted. They're added to the property's basis instead.
Death: the losses are deductible only to the extent they exceed the step-up in basis your heirs receive. The rest is gone.
Like-kind (1031) exchange: because the rule requires a disposition in which all gain or loss is recognized, talk with your tax team before assuming an exchange releases anything.
A sale also triggers tax on your gain, and part of the gain on real property (unrecaptured section 1250 gain) can be taxed at up to 25%. We cover that in our guide to depreciation recapture.
Worked example: Dr. Patel's long-term rental over five years
Dr. Patel is a hospitalist earning $380,000 in W-2 wages. She files jointly, and her spouse works full time outside real estate.
She buys a long-term rental. The rent covers the mortgage and expenses, but depreciation creates a paper loss.
Year 1
Rental loss: $30,000
Household MAGI: well above $150,000, so the $25,000 allowance is $0
Deducted this year: $0
Suspended and carried forward: $30,000
Years 2 through 4
Depreciation keeps producing smaller losses, and each one joins the carryforward:
Year 2 loss $22,000, running total $52,000
Year 3 loss $18,000, running total $70,000
Year 4 loss $15,000, running total $85,000
Year 5
Dr. Patel sells the property to an unrelated buyer in a fully taxable sale. Assume the property roughly breaks even for its final months and she has no other passive income.
Suspended losses released: $85,000
Treatment: nonpassive, so they can offset her gain on the sale and her W-2 income that year
The takeaway: none of the $85,000 was lost. It was deferred until the sale. For a physician in a high bracket, when the losses come loose matters, and that timing is something your tax team can plan around. However, keep in mind that the prior depreciation would have decreased your basis in the property, triggering a gain on the sale of the property.
This hypothetical is for illustration; your results will differ.
What are the exceptions to the passive activity loss rules?
Two paths can make a rental loss nonpassive in the year it happens: real estate professional status and the short-term rental exception. Both depend on material participation, and grouping can affect how you meet it.
Real estate professional status (usually through a spouse)
If you qualify as a real estate professional (REPS), your rentals are no longer passive by default. You still need to materially participate in them, but the automatic label goes away.
Qualifying takes two tests, and on a joint return one spouse has to meet both alone:
More than 750 hours of services in real property trades or businesses where that spouse materially participates.
More than half of that spouse's total working hours spent in those real estate businesses.
The statute is blunt about spouses: on a joint return, the requirements are satisfied "if and only if either spouse separately satisfies such requirements." You can't add your 200 hours to your spouse's 600 to reach 750.
The more-than-half test is what blocks full-time physicians. If you work 2,000 clinical hours a year, you would need more than 2,000 hours in real estate on top of that. So in practice, this plan runs through a spouse who isn't working full time in another field.
A qualifying taxpayer can also elect to treat all rental properties as a single activity, which makes the material participation hours easier to meet. The election is made on a statement filed with the original return and is hard to reverse.
We go deeper on the hour tests and documentation in our real estate professional status guide and our breakdown of real estate professional status requirements for physicians.
The short-term rental exception
Under the regulations, an activity isn't a "rental activity" at all if the average period of customer use is seven days or less. The same goes for an average stay of 30 days or less when you provide significant personal services. Which services count as significant is a technical question for your tax team.
That matters because the passive-by-default rule applies to rental activities. Take a property out of that category, and it's treated like any other business: passive only if you don't materially participate.
So a physician who owns a short-term rental with a short average stay, and materially participates in it, can treat its losses as nonpassive without anyone in the household qualifying for REPS. That's the core of what people call the short-term rental loophole, which we cover in our short-term rental tax loophole guide.
The material participation tests
You materially participate in an activity if you meet any one of seven tests in the regulations. You only need one:
Test | What it requires |
1 | More than 500 hours in the activity during the year |
2 | Your participation is substantially all of the participation by anyone |
3 | More than 100 hours, and not less than any other individual |
4 | The activity is a significant participation activity, and your total across such activities exceeds 500 hours |
5 | You materially participated in any 5 of the preceding 10 years |
6 | A personal service activity you materially participated in for any 3 prior years |
7 | Regular, continuous, and substantial participation based on all the facts (not available at 100 hours or less) |
For short-term rentals, tests 1 and 3 do most of the work, and test 3 is where many physicians land.
If you log 120 hours and your cleaner logs 90, you pass. If the cleaner logs 130, you don't.
One helpful rule: for material participation, your spouse's hours count along with yours. That's different from the REPS tests, where hours can't be combined.
Keep a contemporaneous log. Hours reconstructed at tax time are much harder to defend if the IRS asks. Our post on the 100-hour material participation path walks through what counts.
Should you group your activities?
The regulations let you treat several activities as one if they form an "appropriate economic unit" based on the facts. Grouping can help you meet a material participation test across related properties.
Once you group activities, you generally can't regroup them in later years. The IRS also requires a written disclosure statement with your original return for the first year you group.
Grouping is a decision to make with your tax team before you file, not after.
Worked example: Dr. Nguyen's short-term rental
Dr. Nguyen is an anesthesiologist. Her household files jointly, with taxable income of about $600,000 in 2026 before the rental.
In 2026 she buys and places in service a short-term rental with an average guest stay of four days. She manages it herself and keeps a log showing 120 hours for the year, more than anyone else, including her cleaning service.
Average stay of seven days or less: not a "rental activity"
Material participation: test 3 met (more than 100 hours, not less than anyone else)
Result: the loss is nonpassive
A cost segregation study and bonus depreciation create a first-year loss of $70,000. Because she acquired the property in 2026, the timing works: under current law, qualifying property acquired after January 19, 2025 may be eligible for 100% bonus depreciation. (IRS Notice 2026-11) Our cost segregation guide explains how the study works.
The math (illustrative, 2026 married filing jointly)
Taxable income before the rental: $600,000
Nonpassive rental loss: -$70,000
Taxable income after: $530,000
2026 bracket: 35% applies to taxable income above $512,450 (Rev. Proc. 2025-32), so the entire $70,000 comes off income taxed at 35%
Estimated federal income tax effect: about $24,500 lower
This hypothetical is for illustration; your results will differ.
Before that loss counts, it still has to pass two checks:
Basis and at-risk: she needs enough basis and amount at risk in the property to absorb the loss.
Excess business loss limit: for 2026, net business losses above $512,000 on a joint return can't offset other income that year. Her $70,000 is well under that.
If Dr. Nguyen and her rental were in California, the state result could differ. California's rule is covered below, and her tax team would need to confirm how California treats the short-term rental.
Compare her to Dr. Patel. Both are high earners well past the $150,000 cutoff.
Their results in year one differ sharply anyway, because of how each property is used and how Dr. Nguyen spends her time.
How do passive loss rules interact with basis, at-risk, and excess business loss limits?
The passive rules aren't the only gate. A loss has to clear four limits, in order:
Basis: you can't deduct more than your basis in the activity.
At-risk rules: you can't deduct more than the amount you actually have at risk.
Passive activity rules: the Section 469 limits covered above.
Excess business loss limit: a cap on how much net business loss can offset wages and other income in one year.
The IRS spells out the middle of that sequence in the Form 461 instructions: "First, apply the at-risk rules; next, apply the passive activity loss rules; and then apply the excess business loss rules." (Instructions for Form 461)
The last gate matters more than it used to. The IRS instructions say the One Big Beautiful Bill Act permanently extended the excess business loss limitation.
For 2026, the threshold is $256,000, or $512,000 on a joint return. Anything above that carries forward instead of offsetting other income that year.
The 2026 figure is lower than 2025's, so don't reuse last year's number.
For a physician stacking a large cost segregation loss on a short-term rental, a loss can clear the passive rules and still get capped here.
Does the 3.8% net investment income tax apply to your rental income?
Once your rentals turn a profit, the net investment income tax (NIIT) enters the picture. It's a 3.8% tax that can reach passive rental income once modified AGI passes $250,000 on a joint return or $200,000 for single filers.
The tax applies to the lesser of your net investment income or the amount your modified AGI exceeds the threshold. Like the $25,000 allowance, those thresholds aren't indexed for inflation.
There's a safe harbor for real estate professionals.
If a qualifying real estate professional participates in a rental real estate activity for more than 500 hours during the year (or did in any five of the prior ten years), the regulations treat that rental income as trade or business income, which can keep it out of the NIIT. (Treas. Reg. 1.1411-4)
Physician traps: self-rental, the practice building, and state rules
Renting a building to your own practice
Plenty of practice owners buy their office building personally and rent it to the practice. A specific rule, the self-rental rule, covers this setup.
Under the self-rental rule, if you rent property to a business you materially participate in, the net rental income is treated as nonpassive. The rule recharacterizes only net income, so a net loss from that building generally stays passive.
In practice, that means the building's profit can't soak up passive losses from your other rentals, but a loss from the building doesn't get nonpassive treatment either. If you own or are considering buying your practice's building, factor this in. More in our self-rental rules post.
California and New York
Rules vary by state, and some states, including California, do not follow the federal treatment.
California is the headline example. California's Franchise Tax Board says it "did not conform" to the federal real estate professional exception, and "for California purposes, all rental activities are passive activities." (FTB 3801 instructions, 2025) A California physician household can qualify for REPS federally and still have passive rental losses on the state return.
New York has its own form, IT-182, for nonresidents and part-year residents who report passive activity losses from New York sources. If you moved into or out of New York, or own a New York rental while living elsewhere, expect an extra layer.
How do you report passive losses on Form 8582?
Form 8582, Passive Activity Loss Limitations, is where the IRS calculation happens. It totals your passive income and losses, applies the $25,000 allowance if you qualify for any of it, figures how much you can deduct this year, and tracks what's left as a prior-year unallowed loss.
Most physicians with rental losses will file it. The exception is narrow: only rental real estate with active participation, no prior-year unallowed losses, a total rental loss of $25,000 or less, and modified AGI of $100,000 or less, among other conditions. Most attendings won't fit.
The worksheets matter as much as the form itself. They're the record of your suspended losses by property. Keep them, and hand them to any new preparer.
Passive activity loss FAQs
Can passive losses offset W-2 or other ordinary income?
Not usually. Passive losses offset passive income. They can offset wages if you qualify for the $25,000 allowance, if an exception like REPS or the short-term rental rule applies, or when you sell the activity in a fully taxable sale.
How many years can you carry forward passive losses?
There's no limit. Suspended losses carry forward until you use them against passive income or release them in a qualifying disposition.
Do passive losses offset capital gains?
Suspended losses from an activity can offset the gain when you sell that activity in a fully taxable sale, since the released losses are treated as nonpassive. Passive losses generally can't offset portfolio gains, like gains from selling stocks, in other years.
What is the passive loss limitation for 2026?
The $25,000 allowance and its $100,000 to $150,000 MAGI phase-out are unchanged and not indexed. Separately, the 2026 excess business loss threshold is $256,000 ($512,000 joint).
Make your rental losses count
The passive rules decide when a rental loss becomes useful. For your household, that answer turns on your income, your spouse's hours, how the property is rented, and how you eventually sell.
Before you buy a property or place one in service, have your tax team map which path fits your household: waiting for a sale, the short-term rental route, or REPS through a spouse. Proactive tax planning can potentially reduce your tax liability and spare you the surprise of a large loss sitting unused for years.
Contact your tax team today. You'll get prompt, dependable communication and a plan built around your household.
Disclaimer: This material is intended for educational and informational purposes only and does not constitute tax, legal, accounting, or financial advice. The content is general in nature and may not apply to your specific circumstances. Tax laws and financial regulations are subject to change and interpretation, and the application of these laws can vary based on individual situations. Before making any decisions, you should consult with a qualified tax advisor, legal counsel, or financial professional.
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