Decedent’s Passive Loss Carryover
When a passive interest is transferred due to death, the accumulated suspended losses from the activity are deductible on the decedent’s final return.
The deduction amount is limited to the excess of the basis of the property in the hands of the transferee (heir) over the decedent’s adjusted basis in the property just before death. In other words, the amount of the passive activity loss that equals the step-up in basis due to the decedent's death is not allowed as a deduction to anyone in any tax year. (Code Sec. 469(g)(2))
Example: Robert was the sole owner of a residence used as a rental, a passive activity. When he died his will left the property to his brother Tom. At Robert’s date of death, the value of the rental was $500,000, his adjusted basis was $494,000, and he had unused passive activity losses of $8,000. Since Tom’s basis of the rental is increased by $6,000 ($500,000 – $494,000), the deduction on Robert’s final return for the year of death would be limited to $2,000 ($8,000 - $6,000). If the stepped-up basis had been $502,000 or more, none of the suspended passive loss would have been deductible ($502,000 – 494,000 = $8,000; $8,000 - $8,000 = $0).
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