Updated October 24, 2026. Quick answer: Tax Topic 425 is the IRS page on passive activity losses and credits. It says passive losses that exceed passive income are generally disallowed for the current year and can be carried forward to the next taxable year. Form 8582 is the form used to summarize passive income and losses and compute the deductible losses.
Quick reference
| Item | What the IRS topic says |
|---|---|
| The basic loss rule | “Generally, passive activity losses that exceed the passive activity income are disallowed for the current year.” |
| Disallowed losses | “You can carry forward disallowed passive losses to the next taxable year.” |
| Material participation | “You materially participate in an activity if you’re involved in the operation of the activity on a regular, continuous, and substantial basis.” |
| Rental activities | “In general, rental activities, including rental real estate activities, are passive activities even if you materially participate.” |
| Loss form | “Use Form 8582, Passive Activity Loss Limitations to summarize income and losses from passive activities and to compute the deductible losses.” |
The basic rule for losses and credits
The topic opens with the core rule. It says “Generally, passive activity losses that exceed the passive activity income are disallowed for the current year.” The next sentence is about timing: “You can carry forward disallowed passive losses to the next taxable year.” Credits follow the same pattern, since “A similar rule applies to credits from passive activities.”
What counts as passive is defined in the next section. The topic says “Passive activities include trade or business activities in which you don’t materially participate.” It then explains the participation test, saying you materially participate if “you’re involved in the operation of the activity on a regular, continuous, and substantial basis.”
Rentals, real estate professionals and active participation
Rentals get their own treatment. The topic says “In general, rental activities, including rental real estate activities, are passive activities even if you materially participate.” It then names an exception: “However, rental real estate activities in which you materially participate aren’t passive activities if you qualify as a real estate professional.”
There is a second, narrower exception. The topic says “Also, there’s a limited exception from the passive activity rules for rental real estate activities in which you actively participate.” It draws the distinction this way: “Active participation is a less stringent standard than material participation.”
For the detailed tests, the topic sends readers to Publication 925, Passive Activity and At-Risk Rules. Our page on the Form 8582 special allowance for rental real estate follows that exception line by line.
Selling the activity and the forms
The topic addresses what happens when you leave an activity entirely. It says “Generally, you may fully deduct any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity.” Credits are treated differently: “In contrast, you may not claim unused passive activity credits merely because you disposed of your entire interest in the activity.”
Two forms close the topic. For losses, “Use Form 8582, Passive Activity Loss Limitations to summarize income and losses from passive activities and to compute the deductible losses.” For credits, “Use Form 8582-CR, Passive Activity Credit Limitations to summarize the credits from passive activities and to compute the allowed passive activity credit.” See Form 8582 and Form 8582 lines 1a to 3 on this site.
Where this comes from
This page describes the IRS page titled Topic no. 425, Passive activities: Losses and credits, as served on irs.gov on October 24, 2026. The IRS page shows that it was last reviewed or updated on 24 Sep 2026. The IRS can change a topic after we read it, and the IRS page controls. General information, not tax or legal advice.
Common mistakes
- Treating every rental as non passive once you are involved in it. The topic says rentals are passive “even if you materially participate” unless an exception such as real estate professional status applies.
- Assuming a disallowed loss is simply lost. The topic says “You can carry forward disallowed passive losses to the next taxable year.”
- Treating unused credits the way losses are treated on a sale. The topic says “you may not claim unused passive activity credits merely because you disposed of your entire interest in the activity”
- Using active and material participation as the same thing. The topic says “Active participation is a less stringent standard than material participation.”
Related: IRS tax topics by number, Form 8582, Form 8582 lines 1a to 3, Form 8582 special allowance for rental real estate, Form 8582 Part VIII allowed losses, and Form 6251 passive activity adjustments.
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Answer againSources
- IRS, Topic no. 425, Passive activities: Losses and credits (irs.gov): https://www.irs.gov/taxtopics/tc425
- IRS, Tax topics index (irs.gov): https://www.irs.gov/taxtopics
Read from the IRS pages linked above on October 24, 2026. General information, not tax or legal advice. The IRS topic page and the instructions for your own form control, and your own facts decide the outcome.