IRS tackles interaction of gain exclusion and PAL treatment

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Abstract: It’s not unusual for someone to convert a personal home into a rental property. But such conversions can raise some thorny tax questions when the home is subsequently sold. Passive losses are generally deductible only to the extent of passive income. Rental real estate activities typically are deemed passive activities. This article looks at a recent Chief Counsel Advice memo that makes it clear that the gain excluded under Internal Revenue Code Section 121 isn’t treated as passive gain. It also confirms that the suspended passive activity losses are “freed up” in the year of disposition.