Figures: tax year 2026
An individual's allocated loss can exceed the deduction allowed for tax purposes because separate limitations measure tax investment, economic exposure, and income classification. This lesson addresses losses from pass-through entities and rental activities, expressly excluding tax-credit implications.
The basis limitation restricts deductible pass-through losses to the owner's available tax basis. The at-risk limitation then restricts losses to the owner's qualifying economic exposure. Finally, the passive activity limitation restricts deductions according to participation, eligible income, and specific exceptions.
The ordered walk assigns each rejected dollar once:
For current losses without carryforwards, at-risk-admitted loss equals the minimum of basis-admitted loss and amount at risk. Existing carryforwards enter at their own limitation layer because they already passed earlier tests.
Directly owned rental losses do not have a pass-through owner-basis gate. Asset basis governs depreciation and gain or loss on disposition; allowable operating deductions then face the applicable at-risk and passive restrictions. Entity ownership must be established before imposing an outside-basis or shareholder-basis ceiling.
Common mistakes
- Combining suspended pools. Adrian's mislabeled $80,000 passive balance produces a $50,000 Year 2 deduction instead of the supported $30,000.
- Using fair value for contributions. Substituting Elena's $9,000 property value for its $5,000 basis overstates contribution-based capacity by $4,000.
- Counting investment gains as passive. Adrian's $3,000 interest plus $7,000 stock gain supplies no general passive-loss capacity.
Bottom line
- Basis, at-risk, passive-activity, and excess-business-loss restrictions operate in that order.
- Losses remain assigned to their activity, tax character, and suspension layer until the applicable condition permits use.
- Partnership nonrecourse debt can increase outside basis without increasing economic exposure, while a shareholder guarantee alone does not establish S corporation debt basis.
- General passive losses offset eligible passive income; wages, materially participated business earnings, and portfolio receipts remain outside that pool.
Exam shortcut
Each loss is labeled current, basis-suspended, at-risk-suspended, or passive-suspended before entering the schedule. Debt exhibits establish the obligor, collateral, lender relationship, and reimbursement rights. An unsigned guarantee supplies no enforceable exposure. Income classification follows each receipt's source. Stock investment gains and deposit interest do not become passive because the owner performs no work.
The full lesson (about 10,177 words, 68 min read) adds 6 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- I.B1
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