Can K-1 Losses Really Be Carried Forward? – Avoid This Mistake + FAQs

Yes, K-1 losses can be carried forward – but only if certain tax rules prevent you from using them right away.

In 2023, the IRS processed over 11 million partnership and S-corporation returns, each generating a Schedule K-1 for owners. With so many K-1s flying around, mistakes and missed deductions are common. One big question is whether losses reported on a K-1 can be saved for later.

Understanding how and when you can carry forward those losses is crucial if you want to avoid paying more tax than necessary (or getting a nasty IRS letter).

Here’s what you’ll learn in this ultimate guide:

• 📋 How K-1 loss carryforwards work: When you can carry losses to future years, and why the IRS lets you do it.

• ⚠️ Avoid costly K-1 traps: Common mistakes (basis limits, passive loss pitfalls, etc.) that cause taxpayers to lose deductions – and how to sidestep them.

• 📘 Key tax terms explained: A plain-English glossary for confusing jargon like at-risk, passive activity, and suspended loss, so you’re never left scratching your head.

• 💡 Real-world examples: Three actual taxpayer scenarios (with tables) showing how K-1 losses get carried forward across years – including rentals, business investments, and multi-year loss build-ups.

• 🌎 Federal vs. state rules: How your state might differ from the IRS (full table included for all 50 states) – and why a California landlord or New Jersey investor might face different limits.

Answer First: Can K-1 Losses Be Carried Forward?

An unused K-1 loss isn’t gone forever – it becomes a suspended loss you can potentially deduct later. This carryforward kicks in when tax rules (like basis limits, at-risk limits, or passive activity limits) disallow your loss in the current year. The loss is then saved and rolled over to the next year, and the next, for as long as needed until you meet the conditions to deduct it.

Think of a K-1 loss carryforward as a rain check from the IRS. You couldn’t use the loss now, but you’ve got a ticket to use it in a future year. There’s no fixed expiration on these suspended losses in most cases – they carry forward indefinitely until you either use them or the activity ends.

However, you must follow the rules for each type of limitation to know when you can finally deduct the loss. Here’s a quick overview of those rules (we’ll unpack them in detail later):

• Basis limitation: You can only deduct losses up to the amount you’ve invested in the partnership/S-corp (your tax basis). If a loss exceeds your basis, the extra is suspended and carried forward until you restore enough basis (by adding capital or earning profits).

• At-risk limitation: This rule says you can only deduct the portion of loss for which you are financially at risk. If part of your investment is protected (say, a loan you’re not personally liable for), that portion of loss gets suspended. It carries forward until your at-risk amount increases (or the activity ends with a taxable disposition).

• Passive activity loss (PAL) limitation: If the K-1 activity is passive to you (like a rental property or a business you don’t materially participate in), losses generally can’t offset non-passive income (like your salary). Disallowed passive losses are carried forward to future years. They become deductible in a year when you have passive income to absorb them, or when you sell the activity.

You don’t get to choose to carry them forward; it happens by necessity when the tax rules won’t let you take the loss currently.

The upcoming sections will ensure you know exactly why a K-1 loss might be suspended, how to avoid common pitfalls, and how to eventually make the most of those carried-forward losses.

Avoid These Costly K-1 Traps

K-1 losses can save you money, but only if you navigate the rules correctly. Many taxpayers fall into traps that delay or deny their deductions. Avoid these common K-1 loss mistakes:

• 🚩 Deducting more than your basis: This is mistake #1. If you claim a loss bigger than what you invested, the IRS will disallow it. For example, if you put $5,000 into a partnership and your K-1 shows a $7,000 loss, you can only deduct $5,000. The extra $2,000 is not deductible now. Trap: Some people don’t track their basis and accidentally deduct too much, triggering IRS letters or audits. Avoid it: Keep a yearly calculation of your partnership or S-corp basis. If your K-1 loss exceeds your basis, don’t deduct the excess – carry it forward instead.

• 🚩 Ignoring the at-risk rules: You might have plenty of basis on paper because of loans, but are you at risk for those losses? If your investment is backed by nonrecourse loans (loans you’re not personally liable to repay), the at-risk rules might cap your losses. Trap: Taxpayers often miss filing Form 6198 (At-Risk Limitations) when required, or they assume all basis is at-risk. Avoid it: Determine your at-risk amount each year (generally, money you’ve invested or loans you’re responsible for). If your K-1 loss is larger than the amount you could actually lose economically, expect the excess to be suspended. Always fill out the at-risk form if applicable – it tells the IRS you calculated the allowed loss properly.

• 🚩 Passive vs. active mix-ups: K-1 losses from passive activities (like rental properties or limited partnerships) can’t freely offset active income (like wages or business income where you materially participate). Trap: A common mistake is trying to deduct a passive loss against your salary or other non-passive income in the same year – the IRS won’t allow it. Another trap is misunderstanding the “real estate professional” status or the special $25,000 rental loss allowance – misapplying these can cause disallowed losses or later state tax surprises. Avoid it: Figure out if your K-1 activity is passive for you. If you’re not materially involved day-to-day, assume it’s passive. Use Form 8582 (Passive Activity Loss Limitations) to calculate allowed losses. Remember that rentals are passive by default (unless you qualify as a real estate professional under strict IRS tests). Don’t count on deducting rental losses beyond $25k (if your income allows) unless you’ve met those criteria. And note: even if you do qualify as a real estate pro for federal taxes, some states won’t recognize it (more on that later).

• 🚩 Forgetting to carry losses forward: Believe it or not, some taxpayers forget about their suspended losses in future years. There’s no automatic IRS reminder – it’s on you (or your tax software) to bring those losses forward. Trap: You might leave money on the table by not using prior year losses once they become deductible. For example, if you finally have passive income, but you forgot about the $10,000 passive loss carryover from earlier years, you could overpay your tax. Avoid it: Maintain a carryforward schedule. Your prior year tax return should show suspended losses (on worksheets for basis, at-risk, or passive losses). Each year, update those and apply any that become allowed. If you switch tax preparers or software, double-check that these figures carry over. It’s wise to keep copies of Form 8582 and Form 6198 from prior years – they detail your unused losses.

• 🚩 Publicly Traded Partnership (PTP) confusion: K-1s from publicly traded partnerships (PTPs) have an extra twist. Losses from a PTP can only be used against income from the same PTP (or upon sale of that PTP). Trap: Taxpayers sometimes lump these losses with other passive losses. For instance, a loss from a PTP cannot offset rental income from a different partnership. It gets suspended separately, even if you have other passive income. Avoid it: If your K-1 is from a PTP (often noted on the K-1), isolate that loss. You’ll carry it forward only to use against that partnership’s future income or gain on sale. Don’t mix PTP losses with other passive activities on Form 8582 – they have their own line and rules.

By steering clear of these traps, you ensure that your K-1 losses are handled correctly. That means no lost deductions and no surprise IRS notices. Next, let’s clarify the buzzwords and concepts that often trip people up, so you can tackle the topic with confidence.

Glossary of Terms That Trip People Up

Taxes come with a lot of jargon. Here are some key terms related to K-1 losses and carryforwards, explained in plain English:

• Schedule K-1: A tax form that partners (from partnerships, LLCs) or S-corp shareholders receive each year. It reports your share of the business’s income, deductions, and losses. Think of it as the business telling the IRS, “This is your slice of the pie (or in the case of a loss, your slice of the pie plate).” You use the K-1 info on your personal tax return (Form 1040).

• Basis (Tax Basis): Your investment stake in the entity for tax purposes. It starts with what you paid in or contributed. It increases with income and additional contributions, and decreases with losses and distributions. Basis limits your loss deductions – you can’t deduct more in losses than your basis. If your K-1 shows a loss of $10,000 but your basis is $6,000, you’re only allowed $6,000 this year. The rest is suspended. Basis is like your running tally of skin in the game.

• At-Risk Amount: The portion of your basis that you could actually lose financially. This excludes certain protected or nonrecourse amounts. For example, if you invested $5,000 of your own money (fully at risk) and also have a share of a $10,000 loan that you’re not personally on the hook for, your at-risk amount might only be $5,000. Losses beyond that at-risk amount get suspended by the at-risk rules. It’s possible to have basis (because of a loan) but not be at risk for it – meaning the at-risk rules, not basis, become the choke point on losses.

• Passive Activity: In tax terms, a business or rental activity in which you do not materially participate. Materially participate means you’re actively and continuously involved (think working in the business regularly). If you’re just an investor or a limited partner, it’s likely passive. Rental real estate is automatically passive (even if you work at it) unless you meet the IRS’s real estate professional criteria or qualify for the special $25,000 allowance. Why it matters: Passive losses can only offset passive income (with a few exceptions). If you don’t have passive income this year, the loss becomes a suspended passive loss.

• Material Participation: A measure of involvement in an activity. There are IRS tests (like spending 500+ hours a year in the activity, among others) to determine if you materially participate. If you do, the activity is non-passive (active) to you, and the passive loss rules won’t limit your losses from that activity. If you don’t, it’s passive. For K-1 purposes: general partners or managing members often materially participate; limited partners typically do not.

• Passive Activity Loss (PAL): The loss from a passive activity that is subject to limitation. If your passive losses exceed your passive income in a year, you have a PAL that’s disallowed currently. This PAL carryforward goes to next year. You’ll often see this on Form 8582, which calculates how much passive loss is allowed and how much is carried forward as “Unallowed Passive Losses.”

• Suspended Loss: A loss that you couldn’t deduct due to one of the limitations (basis, at-risk, or passive) and therefore is “suspended” for use in future years. It just sits on your tax records waiting. Suspended losses retain their character. For example, a passive loss stays passive (it’ll only offset passive income later, unless freed up by a complete sale). A basis-suspended loss is waiting until you have basis again. Think of suspended losses as deferred tax deductions.

• Carryforward (Carryover): The mechanism by which a suspended loss moves to the next tax year. Each year, you carry forward prior unused losses until conditions allow them. There’s usually no limit to how many years you can carry forward these losses – they can roll forward indefinitely (except rare cases like some state limits or if you die with unused losses). You’ll keep track of carryforwards on worksheets or forms like 8582.

• Real Estate Professional (REP) Exception: A special tax status that, if qualified, allows rental real estate activities to be treated as non-passive (so their losses aren’t automatically passive). To qualify, you (and your spouse, if filing jointly) must spend 750+ hours a year and over half your total working time in real estate trades or businesses in which you materially participate. It’s a high bar – think full-time real estate investors/agents. If you meet it and materially participate in your rentals, those rental losses can fully offset other income. Important: For federal taxes, REPs can avoid passive treatment, but some states don’t honor this (e.g., California still treats those losses as passive at the state level).

• Active Participation (Rental): A more lenient standard than material participation, related specifically to rental real estate. If you “actively participate” (e.g., make management decisions, arrange for repairs, etc.) in your rental and your AGI is under $150,000, you may qualify for up to $25,000 of rental loss that can offset non-passive income. This is the $25k special allowance. It phases out between $100k–$150k of AGI. It’s not the same as being a real estate professional – it’s easier to meet, but the dollar benefit is capped. Losses beyond that allowance (or for higher-income landlords) become passive carryforwards.

• Publicly Traded Partnership (PTP): A partnership that’s publicly traded (think large pipeline partnerships, etc., traded on stock exchanges). A K-1 from a PTP has special passive loss rules: you can only use passive losses from that PTP against income or gains from the same PTP. You cannot mix PTP losses with other passive activities. Any unused PTP losses carry forward, but only to that PTP’s future income or to fully deduct when you sell your entire interest in that PTP.

• Form 6198: The tax form for At-Risk Limitations. If you have losses from a K-1 (or other business) and some of your investment isn’t at risk, this form calculates your allowed loss. It shows your at-risk amount and how much loss is disallowed (carried forward) due to the at-risk rules. Filing this helps document your suspended at-risk losses.

• Form 8582: The Passive Activity Loss Limitations form. Non-corporate taxpayers use it to sum up all passive activities, figure out how much loss (if any) is allowed in the current year, and how much is disallowed and carried forward. It’s your friend for tracking passive K-1 loss carryforwards year to year. (Estates and trusts have a similar form, 8582-CR or 8810 for certain entities.)

• Excess Business Loss (EBL): A newer limitation (as of recent tax law) that isn’t K-1 specific but can affect folks with large overall losses. If you have too much aggregate business loss in a year (from all sources, including K-1s, Schedule C, farming, etc.), the amount over a certain threshold (around $540,000 for a married couple in 2025, adjusted annually) becomes an NOL (Net Operating Loss) carryforward instead of a current deduction. In plain terms, very large losses might be capped in the current year even after basis/at-risk/passive rules. The excess portion carries forward as an NOL to future years. This rule ensures uber-large losses still get spread out over time.

With these terms defined, you’ll be better equipped to understand the mechanics in the upcoming examples and discussions. Now, let’s look at how K-1 loss carryforwards actually play out for real taxpayers.

How This Works in Real Life: Examples from Actual Taxpayers

Theory is one thing – real life is another. Let’s walk through three scenarios based on typical taxpayers who have K-1 losses. These examples will show when losses get carried forward, how they accumulate, and when they finally get used. We’ll use simple numbers and scenarios so you can see the patterns.

Example 1: Passive Rental Loss Carryforward (Linda’s Rental LLC)

Linda invests in a small rental property via an LLC (treated as a partnership). She doesn’t qualify as a real estate professional, and her income is high, so she can’t use the $25,000 special rental loss allowance either. This means her rental losses are fully passive. If she has no other passive income, any loss will carry forward. After a few years, she decides to sell the property. Here’s what happens year by year:

What’s happening here? In years 1 and 2, Linda had rental losses but no passive income, so the losses just suspend. By end of year 2, she’s accumulated $18k of passive losses carried forward. In year 3, she finally had $5k of passive income (say from another K-1 investment that produced income). That allowed her to deduct $5k of the passive losses (offsetting that income). She still generated a new $9k loss in year 3, so her carryforward grew to $22k by year’s end. In year 4, she sells the property. When you dispose of a passive activity in a fully taxable sale, the passive loss rules no longer apply to that activity – meaning all those suspended losses become deductible. Linda’s $22,000 of suspended losses get released. They first offset the $15k gain from the sale of the property, and the remaining $7k can offset other income as well (when passive losses are freed by a sale, they can even offset active income in that final year). By the end of year 4, her carryforward is back to $0. She used every dollar of those losses (some against the sale gain, the rest against other income).

Key takeaways: Passive losses can carry forward indefinitely until you either have passive income or sell the activity. A sale frees all remaining losses for that activity. Without a sale or passive income, losses just keep accumulating (Linda’s case through year 2). But they’re not wasted – they’re just waiting for the right time.

Example 2: Active Owner with Basis Limits (Jason’s S-Corp Investment)

Jason is an active owner of an S-corporation that develops apps. He materially participates (so not passive), but he only put in a certain amount of money. Basis is the issue here. Let’s say he invested $5,000 of his own cash for stock. In year 1, the S-corp has a bad year and his K-1 shows a $8,000 loss. Jason can only deduct up to his basis. At year-end, he decides to loan the company an additional $2,000 (which gives him debt basis in an S-corp). In year 2, the company turns a profit.

Here’s how Jason’s losses carry forward and get utilized:

Year 1: Jason had only $5k of basis to start. The S-corp loss was $8k. He deducts $5k (bringing his basis to zero). The extra $3k of loss is suspended due to basis limitation – he can’t use it in Year 1. It carries forward. By loaning the company $2k at year-end, he creates $2k of debt basis going into Year 2 (in S-corps, loans from shareholder to corporation count as basis for loss purposes).

Year 2: Now the K-1 shows $4k of profit (income). Income increases Jason’s basis. But importantly, Jason also has that $3k suspended loss from prior year waiting. Here’s how it works: At the start of Year 2, his basis was $2k (from the loan). During Year 2, the company earned $4k, which would add to basis – but tax-wise, you typically handle the carryforward first. Essentially, as Year 2 closes, Jason has $4k of income, which increases basis allowing him to use that prior $3k loss. He uses the $3k suspended loss against the Year 2 income. So on his 1040 for Year 2, he reports net $1k of S-corp income (the $4k current income minus the $3k prior loss now allowed). After using that loss, his basis at end of Year 2 will actually still increase by the portion of income not offset. Let’s break that down: beginning basis $2k + income $4k = $6k, then he takes the $3k loss (which reduces basis again) leaving $3k basis at year-end. (We don’t necessarily need the exact basis figure after, but the key is the suspended loss got used.)

By the end of Year 2, the $3,000 that was suspended is fully deducted. Jason has no more suspended losses. All it took was either adding basis or earning income to soak it up – in this case, both happened (he added a loan basis and the business became profitable).

Key takeaways: If you run out of basis, your losses pause. They’ll resume when you restore basis by putting in more money or when the business earns income (because income gives you more basis). An S-corp owner must remember to count both stock and loan basis. In a partnership, contributions or allocated income would similarly restore basis. The order of events can get tricky, but essentially: Year 2’s profit allowed Jason to use Year 1’s disallowed loss. The tax outcome was that over the two years combined, he did get the full $8k of losses deducted ($5k in year 1, $3k in year 2 against income).

Example 3: Multi-Year Suspended Loss Build-Up (Mark’s Limited Partnership)

Mark is a limited partner in a venture that drills wells. He doesn’t participate – it’s purely an investment (so it’s passive for him). Also, the partnership’s losses are funded partly by nonrecourse loans, meaning Mark isn’t at risk for all the losses. This scenario will show multiple years of losses stacking up due to both at-risk and passive limits, without any sale during the period.

Suppose Mark’s at-risk amount is only $2,000 (even though his basis might be higher) because most of the funding is nonrecourse debt. Each year the K-1 shows a loss, and Mark has no other passive income. We’ll track the suspended loss each year:

Let’s decode this:

• In Year 1, Mark’s K-1 loss is $5,000. But he’s only at risk for $2,000. So out of the $5k loss, $3k is disallowed due to at-risk rules immediately. $2k is allowed by at-risk/basis rules. However, even that $2k can’t actually offset Mark’s other income because the activity is passive and he has no passive income. So effectively the full $5k is suspended as passive loss. (In practice, $3k would be on an at-risk carryforward, and $2k on a passive carryforward, but for Mark, either way none of the $5k hit his taxable income in Year 1.)

• In Year 2, another $5,000 loss. Mark still hasn’t increased his at-risk (assume no change), so again $3k is disallowed by at-risk, $2k allowed. No passive income to use any of it. Now he has $10k total suspended (some portion is “at-risk suspended,” some “passive suspended,” but we’re combining for simplicity).

• In Year 3, a smaller $3,000 loss (maybe the venture scaled down). Perhaps he had paid off some nonrecourse debt or added a bit, making his at-risk amount $3,000 now – meaning $1,000 of this year’s loss is at-risk allowed, $2,000 is not at risk. Still no passive income. So the suspended pile grows to $14k by end of Year 3.

• Year 4 finally brings good news: the K-1 shows $2,000 of income (passive income). Now Mark can utilize $2,000 of those suspended passive losses. The passive income is fully sheltered by $2k of his carryforward. After that, he still has $12,000 of losses carrying forward to Year 5 and beyond.

Mark hasn’t sold his interest yet, so those losses continue to carry on. If in a future year the partnership hits a gusher of income, he can use more. Or if he sells out entirely, all remaining suspended losses would be released (with a caveat: any loss suspended due to at-risk limitations is only freed up to the extent of any gain recognized on disposal; purely at-risk disallowed losses with no prospect of becoming at risk could be lost if the activity ends without you ever getting at risk for that amount).

Key takeaways: In multi-year scenarios, it’s possible to accumulate a large pool of suspended losses. Different rules (basis, at-risk, passive) can simultaneously restrict your losses. But eventually, income or disposition will trigger their use. It’s crucial to keep track each year of how much is suspended and why. In Mark’s case, he should track an at-risk carryforward (for the portion limited by at-risk) and a passive carryforward. The first year he actually had $2k at-risk allowed that was passive-limited, which is a bit of a layered limitation. If Mark never had that Year 4 income, all $14k would just sit suspended until some future event. This shows that patience is sometimes needed – tax losses don’t always give an immediate benefit, especially for passive investments, but they can deliver value later on.

Now that we’ve seen examples in action, let’s confirm why all this matters by looking at the rules and enforcement side.

Proof It Matters: IRS Rules, Code Sections, and Real-World Enforcement

You might wonder, “Do I really need to worry about all these rules?” The answer is yes – these limitations are written into the tax code, and the IRS enforces them. Here’s the proof and why it matters:

• Internal Revenue Code (IRC) Sections: The rules for carrying forward K-1 losses are grounded in specific laws:

  • IRC §704(d) – Partnership loss limitation. It says a partner’s share of losses is allowed only up to the partner’s basis in the partnership. Excess losses are carried forward. This is why partnership K-1s often come with basis worksheets – by law, you can’t deduct beyond your outside basis.

  • IRC §1366(d) – S-Corporation loss limitation. Similar to 704(d), but for S-corp shareholders: losses can’t exceed your stock and loan basis in the S-corp. Excess is carried forward (but unlike passive losses, these don’t get a free pass at disposition – if you leave the S-corp with suspended basis losses, they vanish unless you restore basis first).

  • IRC §465 – At-Risk rules. Introduced to stop shelters where people had “losses” with no real money at stake. If you’re not at risk for an amount, you can’t deduct losses against it. Disallowed losses under §465 carry forward indefinitely until you have more at-risk investment or you dispose of the activity. (If disposed, any remaining not-at-risk losses are generally lost, except to the extent you had gain on the sale which can increase your at-risk for that moment).

  • IRC §469 – Passive Activity Loss rules. Enacted in the Tax Reform Act of 1986 (when Congress cracked down on tax shelters). This is the big one for passive losses. It automatically suspends passive losses that exceed passive income. Those losses carry forward as long as it takes until you have passive income or dispose of the activity. Notably, §469 has special sub-rules: the $25,000 rental loss exception (§469(i)) and the Real Estate Professional exception (§469(c)(7)). These provide some relief, but if you don’t meet their criteria, your rental losses stay passive. The code also specifies the publicly traded partnership carve-out (§469(k)), which we mentioned earlier.

  • IRC §461(l) – Excess Business Loss limitation (for years 2018–2026, possibly extended). This one isn’t K-1 specific, but it can cap how much total business loss you use in a year. If you exceed the threshold (around $270k single or $540k joint, varying by year), the extra turns into an NOL. So even if basis/at-risk/passive didn’t stop your loss, this could. For example, a large K-1 loss of $600k (with no limitations otherwise) for a joint filer would be allowed only up to $540k (if that year’s limit), and the remaining $60k carried forward as an NOL. This ensures even very large losses get effectively carried forward.

• IRS Forms and Instructions: The IRS makes you account for these rules on your tax forms:

  • As mentioned, Form 6198 (At-Risk) and Form 8582 (Passive Loss) are where you formally compute allowed vs. suspended losses each year. If you have K-1 losses, these forms often must accompany your return. The very presence of these forms shows the IRS is gathering info on your carryforwards.

  • The Schedule K-1 instructions themselves (for Form 1065 partnerships and 1120-S S-corps) remind you: “If you have losses, you must apply basis, at-risk, and passive limitations before deducting.” They also note that it’s the taxpayer’s responsibility to track carryforward amounts. The IRS expects you to carry them forward properly.

  • Form 7203 is a newer form (for S-corp shareholders) to help track stock and debt basis. Starting in recent years, the IRS requires S-corp owners claiming a loss or distribution to attach Form 7203 (or equivalent basis calc). This is to enforce the basis rules. If you don’t provide it and claim a loss, the IRS may send a notice.

• Enforcement actions: The IRS has been actively enforcing these limitations:

  • Letter 5969: In 2019, the IRS began sending out soft notices (Letter 5969) to S-corp shareholders who claimed losses without attaching a basis computation. The letter basically says, “We think you might have deducted more than your basis allows. Please check and correct it.” This initiative alone shows the IRS is watching K-1 loss claims.

  • Audits and flags: While overall audit rates are low, certain things can raise a flag. For instance, large K-1 losses relative to your investment might draw attention. The IRS might ask for your basis calculations or proof of at-risk amounts. If you can’t substantiate basis or material participation, they can disallow the losses. Passive loss issues also come up in audits, especially for people claiming to be real estate professionals – the IRS often asks for proof of hours and involvement.

  • Tax Court cases: There are many tax court cases where losses were denied because the taxpayer failed one of these rules. E.g., cases where a partner tried to deduct losses but the court found they had no economic outlay (basis) or weren’t at risk for the amounts. Other cases involve passive loss disputes – for example, a taxpayer claiming they were active in a business when they weren’t, or not properly grouping activities. The courts routinely uphold the IRS on suspending those losses until conditions are met.

  • State enforcement: State tax authorities also enforce these rules on state returns. For example, California’s Franchise Tax Board may adjust your state return if you deducted losses as a real estate professional (since CA doesn’t allow that – it will reclassify them as passive and carry them forward). States like New York require forms (like NY IT-182) mirroring the federal Form 8582 to compute allowed passive losses for state purposes.

• Why it matters to you: If you ignore these rules, best case is you’ll get a correction that reduces your current-year deduction (with your loss carried forward instead). Worst case, if you consistently flout the rules or fail to track basis, you could lose the deduction entirely (for example, if years pass and you never realize you had to carry it forward, or you dispose of an interest and hadn’t tracked things). Plus, underpaying tax in a year by over-deducting can lead to penalties and interest when the IRS catches it. On the flip side, following the rules means you will get the benefit of the loss eventually. It might save you a huge tax bill in a future year (like when you sell a business). These rules also prevent you from accidentally cheating yourself – e.g., if you didn’t know you could carry forward a disallowed loss, you might think it was just lost and never claim it later. Knowing the carryforward rules ensures you get every tax dollar you’re entitled to, just at the right time.

In summary, the tax code sets clear limits on K-1 losses, and both the IRS and state agencies pay attention. By understanding the code sections and filing the right forms, you not only stay compliant but also preserve your losses for future use. Now, let’s compare the three different limits we’ve been discussing – basis, at-risk, and passive – because understanding their differences can help you plan and optimize your tax situation.

Battle of the Limits: Basis vs. At-Risk vs. Passive Loss Rules

We’ve talked about three major loss limitations (basis, at-risk, passive). They often work together, back-to-back, creating layers of rules. Here we’ll break down how they differ and why each exists. It’s a battle of the limits, but remember – they’re not fighting each other so much as lining up in a sequence. The general order is: Basis first, then At-Risk, then Passive.

• Basis Limitations – “How much have you invested?”
  What it is: A measure of capital investment. For partnerships, this is your outside basis; for S-corps, your stock basis (plus any direct shareholder loans as a separate basis for losses).
  Why it exists: To ensure you can’t deduct losses in excess of your economic investment. If you haven’t put the money in (or had taxed profits reinvested), you can’t take it out as a loss.
  When it bites: When losses + distributions exceed what you’ve invested and retained. New investors or those who’ve taken distributions often hit this limit. For example, if you only invested $1,000 and the venture loses $5,000 (your share) – you’re capped at $1,000 deduction.
  Carryforward: Any disallowed loss due to basis is carried forward indefinitely until you have more basis. More basis can come from additional contributions, your share of future profits, or (for partnerships) an increase in your share of liabilities. If you leave the partnership or S-corp before restoring basis, those losses disappear (there’s no recapture on sale like passive losses – basis-suspended losses are just lost if you can’t create basis before exiting). So it’s crucial to track and adjust basis if you plan to utilize those losses.
  Planning tip: If you know a loss is coming, you might increase basis (contribute cash or make a shareholder loan by year-end) to take the deduction. S-corp owners often do this – e.g., loan the company money so they have debt basis to deduct a loss. Just be mindful that loans must be bona fide and, for S-corps, directly from the shareholder (not from, say, the corporation borrowing from the bank with your guarantee – that generally doesn’t count as your basis).

• At-Risk Limitations – “Are you on the hook if it all goes south?”
  What it is: A measure of true economic risk. It starts with your basis and then excludes portions for which you’re not personally liable or protected from loss. At-risk amount includes cash you put in, property contributed, and debts you’re personally responsible for (recourse loans or qualified nonrecourse financing on real estate). It excludes most other nonrecourse debt and any guarantees or stop-loss arrangements that effectively remove your risk.
  Why it exists: Added in the late 1970s (IRC §465) after tax shelters let people deduct huge losses with borrowed money they’d never have to repay if the venture failed. Congress wanted to limit losses to the amount you could actually lose.
  When it bites: If your investment is funded by a lot of nonrecourse debt or guarantees. For instance, suppose you have $10k of basis, but $8k of that is from a loan you aren’t personally liable for. You might only be “at risk” for $2k. If you get a $5k loss, at-risk rules would cap you at $2k deduction. Even though basis-wise you looked okay ($10k basis), at-risk says nope, only $2k.
  Carryforward: Losses disallowed for at-risk get carried forward until you increase your at-risk amount. How to increase at-risk? Pay down nonrecourse debt, contribute more personal funds, convert loans to personal liability, or earn income (profits increase your at-risk, since profit that isn’t distributed is money at stake). If you eventually sell the activity: any suspended at-risk losses can be used to offset gain from selling the interest (because that gain effectively puts some skin in the game), but if you sell and still have at-risk suspended losses beyond any recognized gain, those losses are lost for good.
  Planning tip: If you’re bumping against at-risk limits, see if you can restructure debt to be personally liable (if you’re willing and it makes economic sense – tread carefully). For real estate, “qualified nonrecourse financing” (like a mortgage from a bank on real property) is treated as at-risk, which is helpful – ensure loans meet those qualifications if possible. Also, don’t confuse at-risk with basis: always apply basis first, then at-risk. It’s possible to have basis and still fail at-risk (like the example above).

• Passive Activity Loss Rules – “Are you actively involved or just along for the ride?”
  What it is: A classification of activities into passive vs non-passive (active), and a set of rules that restrict passive losses to only offset passive income. It’s not measuring money, but rather participation. If you’re not materially participating in an income-producing activity, it’s passive to you. Rental activities are by default passive (unless exceptions apply).
  Why it exists: To prevent taxpayers from using losses from passive investments (like tax shelters, rental properties, limited partnerships) to offset salaries, professional income, or other “active” income. Before 1986, high earners would invest in loss-generating shelters to wipe out their other income – passive loss rules largely stopped that.
  When it bites: Whenever you have a loss from an activity that you don’t materially participate in, and you don’t have other passive income. For example, you invest in a partnership as a silent partner and it loses money – you can’t deduct that against your job income or portfolio income in the current year. It becomes a PAL carryforward. Another common bite: rental real estate losses for high-income landlords often get suspended because of this rule (unless they qualify for the special $25k offset and their income is under the phase-out).
  Carryforward: Disallowed passive losses are carried forward indefinitely until you either (a) have passive income to soak them up, or (b) dispose of the activity in a taxable fully-disposition. On a full sale (to an unrelated party), the suspended losses on that activity are freed and can offset any kind of income. If you only sell part of your interest, the proportional losses remain suspended (they only free up on an entire disposition of your entire interest in the activity). One caution: if you gift or dispose of the interest without a taxable event (e.g., gift to a family member, or the partnership liquidates without enough income), those losses can be lost. And if you sell to a related party, the losses stay suspended (the tax code doesn’t let you free them if the sale is not arm’s length).
  Planning tip: Try to generate some passive income to utilize losses. This could mean acquiring another passive income source or grouping activities for material participation. For instance, if you have multiple passive activities, one might produce income that can allow deduction of losses from another. Or, if you have the ability to materially participate (turn a passive activity into active), you could do so prospectively – but note, making something non-passive means new losses won’t be passive, though it doesn’t automatically free prior suspended ones until you dispose or have passive income. Real estate investors sometimes plan to use accumulated losses in the year they sell property – essentially “saving” the losses to wipe out gain on sale (as Linda did in Example 1). That can be a smart strategy since it effectively shelters the appreciation from tax.

Which limit is the real culprit? In any given situation, you need to identify which limit (or limits) are at play:

• If you materially participate and have plenty of basis, passive loss rules don’t apply (you’re not passive) and basis is fine – you likely can deduct the loss fully. Your losses would only carry forward if the Excess Business Loss rule kicks in for a very large loss.

• If you’re passive in the activity, even if you have basis and are at risk, you may still get stuck with a carryforward due to passive loss limits.

• It’s possible to be tripped up by all three in sequence: e.g., a limited partner (passive) who has a small capital investment and mostly nonrecourse debt. First, basis limits might disallow some loss, then at-risk might further disallow, and finally any allowed portion is still passive-limited. In such cases, you carry forward due to the first limit that hits, and the others just remain factors in future years.

• Basis vs At-Risk: Often for partnerships, basis includes certain nonrecourse debt, so you might have a high basis but at-risk removes some of it. For S-corps, nonrecourse corporate debt doesn’t give basis at all, so usually basis and at-risk are more aligned for S-corp shareholders (they typically both equal the cash + direct loans in). But partnership basis will credit you for your share of the partnership’s liabilities (recourse or qualified nonrecourse). That’s why at-risk is crucial in partnerships – it pares back that part of basis that isn’t truly at risk for you.

• Passive is an “after-the-fact” limit: You could have plenty of basis and be fully at risk – and still can’t deduct a dollar because you don’t materially participate. In that sense, the passive rule is often the final filter.

In sum, basis, at-risk, and passive loss rules each serve a different purpose:

• Basis = “don’t deduct what you didn’t put in.”

• At-Risk = “don’t deduct what you can’t lose for real.”

• Passive = “don’t deduct if you weren’t actively involved (until you have passive income or sell).”

Understanding these differences can help you structure your investments. For example, contributing enough capital or arranging financing properly can solve basis/at-risk issues, while spending more time in the business can solve passive issues (by making it non-passive). But always tread carefully and within the law – these rules have detailed definitions.

Next, we’ll examine how different states handle these loss carryforward rules. State taxes can throw a wrench in the works, with some not following the federal playbook.

Federal vs. State Differences

When it comes to K-1 losses and carryforwards, federal law is just one side of the coin. State tax laws can differ significantly. Many states use federal taxable income or federal adjusted gross income as a starting point, which means they implicitly follow things like passive loss limitations. However, some states decouple from certain rules or have their own adjustments. It’s important to know your state’s stance, because a loss you carry forward for IRS purposes might be treated differently on your state return.

Below is a state-by-state rundown of conformity to the federal passive loss rules and any notable differences. (Basis and at-risk rules are generally followed by states since they’re part of computing income, but the biggest variations come with passive losses and rental loss exceptions.)

State Highlights:

• States with no income tax (or no relevant tax) don’t impose these limitations at all – because there’s nothing to offset. Your carryforward is purely a federal matter in those cases.

• California and Hawaii stand out for not allowing the real estate professional exception. This means a federal deduction you got as a real estate pro will be added back on the state return and instead carried forward as a passive loss for state purposes.

• New Jersey and Pennsylvania are outliers in that they largely do not allow passive loss carryforwards (or even current deductions across different income streams) in their personal income tax systems. Losses in pass-throughs might be lost if not usable in the current year against similar income in those states. This is a big difference – for NJ/PA taxpayers, a “suspended” federal loss could be a “permanently non-deductible” state loss.

• Most other states, especially those that piggyback on federal AGI/taxable income, will naturally enforce the same limitations as federal. They don’t usually require separate calculations because the federal calculation of allowable loss flows into the state return. Some states, like New York (for part-year/nonresidents) or California, have additional forms just to ensure proper tracking of state-allowed losses.

Action item: Always check your state’s instructions for handling K-1 losses. You might need to file a state version of the passive loss form (e.g., CA FTB 3801, NY IT-182). And be aware that a loss carried forward federally could have a different fate at the state level. If you move from one state to another, remember that passive loss carryforwards don’t transfer between states – they remain with the state where they originated (states won’t let you deduct a loss against their income that wasn’t subject to their tax in the first place). For instance, if you accrued passive losses from a California rental, then move to Texas (no income tax) and sell the property, you won’t have a CA return anymore to use those losses – effectively, you’d lose the benefit of them in CA. Some planning (like choosing to sell while still a CA resident) might preserve the usage of those losses.

Now that we’ve covered state nuances, let’s weigh the general pros and cons of carrying forward K-1 losses. It’s not all sunshine, but it’s not doom either – it’s a mix of delayed gratification and potential pitfalls.

Pros and Cons of Carrying Forward K-1 Losses

Is having a K-1 loss carryforward a good or bad thing? It depends. Here are the upsides and downsides of suspended K-1 losses:

Pros:

• Future Tax Relief: A carried-forward loss is like money in the bank for a future tax year. When you eventually can deduct it, that loss can reduce your taxable income, potentially in a year when you really need it. For example, accumulating passive losses now might later fully offset a big passive income event (like the sale of a property or business), saving you a hefty chunk of tax in that year.

• Maximizing Overall Deductions: By carrying forward until allowed, you ensure you eventually utilize the loss rather than losing it entirely. The tax law could have said “excess loss is forfeited,” but instead it gives you unlimited time (federally) to use it. So the pro is, you don’t lose the deduction, you just postpone it. It’s especially useful if you foresee passive income or a sale down the line – those suspended losses will then act as a shield.

• Compliance = Avoided Penalties: By properly carrying forward losses (instead of claiming them when not allowed), you avoid IRS trouble. That’s peace of mind – no nasty audits or penalties for improper deductions. You’ll also have cleaner records knowing exactly what losses are still available to you.

• Timing Benefits: In some cases, carrying a loss forward might mean using it in a year when you’re in a higher tax bracket, yielding more tax savings. For instance, imagine you’re in a 22% bracket in the loss year but might be in a 32% bracket in a future year when the loss becomes available – that loss is more valuable later. Also, using losses against a large one-time income (like a sale or big passive income year) can prevent you from being pushed into higher brackets or triggering things like the Net Investment Income Tax, etc.

• Potential State Benefits Later: If you couldn’t use a loss in a high-tax state now (like CA passive loss), it’s sitting to be used in a future year – possibly preventing double taxation of the same income (like if your federal gain on sale would be taxed, but the suspended CA losses wipe out the state taxable gain). In states that do allow carryforwards, it ensures you eventually get the state tax break too. (Pro and con: as noted, some states won’t give it at all – but for those that do, the pro is similar to federal.)

Cons:

• Delayed Benefit (Time Value Lost): The biggest downside is you don’t get the tax deduction now. That means you could be paying higher tax in the current year and waiting years to get the benefit. In finance terms, a dollar saved today is worth more than a dollar saved later (time value of money). If you have to wait 5 years to use a loss, you’ve essentially given the government an interest-free loan of the extra tax you paid in the meantime.

• Risk of Never Benefiting: In some cases, you might never actually get to use the suspended loss. This can happen if the business never turns around, and you exit without a qualifying disposition. For example, if you walk away from a partnership interest without selling it (or you sell for a small amount), you might not trigger the release of passive losses or you might not restore basis. Or if you move to a state with no income tax after accruing state-level losses, those state losses might evaporate. In the unfortunate event of the taxpayer’s death, suspended passive losses expire (they don’t transfer in full to heirs – though heirs get a stepped-up basis which indirectly accounts for some of it, any excess passive losses die with the taxpayer). So there’s a con: suspended losses are not a sure thing if circumstances change.

• Complexity and Record-Keeping: Carrying losses forward introduces a lot of paperwork and tracking. You have to maintain records year over year, track your basis, at-risk amounts, and passive loss carryforwards. It’s easy to make mistakes or forget, especially over many years or if you change preparers. This complexity sometimes leads people to miss out on the deduction later (the inverse of a pro). It can also mean higher tax prep fees – your CPA will charge for the extra schedules and calculations each year.

• No Offset to Current Income: If you’re carrying forward a loss, by definition it didn’t offset your other income this year. That can mean higher current-year tax liability. For someone counting on a K-1 loss to reduce taxes, finding out it’s suspended can be a cash flow hit. For instance, without the loss, maybe you owe thousands more in tax this year. That can sting, even if you’ll get a benefit in future years.

• Opportunity Cost and Uncertainty: Tax laws can change. While passive losses and basis rules have been stable for decades, one can’t rule out future changes that might affect carryforwards. For example, the excess business loss rule turns disallowed amounts into NOLs, which then are subject to separate rules (like the 80% of income limitation for post-2017 NOL usage). If you carry forward a loss as an NOL, now it’s under new constraints. There’s also an outside chance Congress could alter passive loss rules (though unlikely to retroactively harm accumulated carryforwards, it’s something to note). So the con is, you are at the mercy of future tax conditions to finally reap the benefit.

In short, carrying forward K-1 losses is a double-edged sword. Pro: you eventually get a deduction, potentially at a more opportune time. Con: you lose the immediate gratification and you must keep everything in order to eventually cash in that “tax IOU.” Ideally, you’d prefer to use losses as soon as possible (a bird in hand). But if you can’t, at least the system gives you later chances. The key is to stay on top of your carryforwards so that when the moment comes, you actually use them.

FAQs from Forums Like Reddit

Let’s answer some quick-hit questions people often ask online about K-1 losses and carryforwards. These are concise yes-or-no style answers for clarity:

Q: Do K-1 losses carry forward to the next tax year if I can’t use them this year?
A: Yes. If a K-1 loss is disallowed in the current year (due to basis, at-risk, or passive limits), it will carry forward to next year. It stays available indefinitely until you meet conditions to deduct it.

Q: Can I deduct a K-1 loss against my W-2 salary or other active income?
A: No. Not in the year of the loss if it’s from a passive activity. Passive K-1 losses generally cannot offset wage or business income. They’re suspended and carried forward unless you have passive income or sell the activity.

Q: Do K-1 losses ever expire or get “used up” if I don’t use them right away?
A: No. Under federal rules, suspended K-1 losses don’t expire with time. They carry forward indefinitely. They only disappear if you dispose of the activity without getting to use them (or at death). Otherwise, they remain until you can deduct them.

Q: Will selling my interest in the partnership free up my suspended passive losses?
A: Yes. If you sell your entire interest in a passive activity in a taxable transaction, all suspended passive losses from that activity become deductible in that year. They can even offset non-passive income once released. (Just make sure it’s a full disposition to an unrelated party to qualify.)

Q: Can a CPA or tax software track my K-1 loss carryforwards for me?
A: Yes. Good CPAs and tax software will carry forward your suspended losses each year. They’ll apply them when allowed. However, you should also keep records and ensure the numbers roll over correctly, especially if you change preparers or software.

Q: If my state taxes don’t allow a K-1 loss now, will they carry it forward like the IRS?
A: It depends. Many states do follow federal carryforward rules (yes, they’ll carry it forward). But some states (e.g., NJ, PA) say no – they don’t allow the loss at all or a carryforward. Check your state’s specific rules.

Q: Can K-1 losses create a Net Operating Loss (NOL)?
A: Yes (indirectly). If a K-1 loss is fully deductible (not suspended by basis/at-risk/passive) and it contributes to a negative overall income on your return, it can be part of a net operating loss that carries forward. Also, an Excess Business Loss turns into an NOL. But if the K-1 loss is suspended, it won’t be in the NOL until a year you actually deduct it.

Q: Is there a limit to how much K-1 loss I can use in one year?
A: Yes. The limits come from basis, at-risk, passive rules, and the excess business loss rule. If none of those apply, there’s no general cap – you could use it all. But practically, high losses get capped by one of those rules in the year. Once carried forward, when they are allowed, you generally use them fully in that year (except NOLs have an 80%-of-income usage limit in years after 2020).

Q: Should I invest more money if I want to deduct a K-1 loss that’s suspended?
A: Possibly. If basis is your limiting factor, contributing more capital or making a loan can increase your basis and at-risk, which may free up the loss. Yes, that can work, but only do so if it makes business sense – don’t invest just for a deduction without considering the overall financial picture.