Dear Tax Talk,
What happens to “unallowed losses” on a Schedule E rental property? Due to a brief increase in income for two taxable years, I was unable to take ordinary income losses from a rental house. (The losses were reported on Form 8529.)

The house was sold in June 2013 at a profit. Are the losses used to adjust my basis? Do I just forget about them and walk away?
— Marion

Dear Marion,
Congratulations on the sale of your property. The good news is that the rental losses that were not deductible because of your higher income in prior years are going to be allowed on your 2013 income tax return since you have sold the property. Fortunately, with these types of losses you do not have to “forget about them and walk away.”

To answer your first question: No, you do not use the losses to adjust your basis. Instead, you will calculate your deductible losses on Form 8582, which is used to calculate passive activity loss limitations. Please note: The Internal Revenue Service does not have a Form 8529 as you mentioned, and I am assuming that Form 8582 is the form that you used on your prior-year tax returns to calculate the amount of your deductible rental losses. In looking at the Form 8582 that is currently available from the IRS website, you will see that line 1c is where you enter your “prior year unallowed losses.” Be sure to complete Worksheet 1 on Page 2 of Form 8582 because it is required.

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