What Is the Passive Activity Loss Rule?

The passive activity loss (PAL) rule limits your ability to deduct losses from passive activities — businesses you don't materially participate in, plus most rental properties — to the amount of income you earn from other passive activities. If your passive losses exceed your passive income, the excess losses are suspended and carried forward indefinitely until you have sufficient passive income or until you sell the passive activity entirely. The most common application is rental real estate: most landlords' rental losses are treated as passive, with a limited exception allowing those who actively participate and have AGI under $100,000 to deduct up to $25,000 of rental losses against ordinary income annually. Real estate professionals who spend more than 750 hours per year in real estate activities can treat their rental income and losses as non-passive, freeing them from this limitation entirely. Understanding the PAL rules is critical for anyone investing in rental properties, limited partnerships, or other ventures where they're not actively running the day-to-day operations.