Topic 425 – Passive Activities – Losses and Credits
Generally, losses from passive activities that exceed the income from passive activities are disallowed for the current year. You can carry forward disallowed passive losses to the next taxable year. A similar rule applies to credits from passive activities.

Material and Active Participation
Passive activities include trade or business activities in which you don’t materially participate. You materially participate in an activity if you’re involved in the operation of the activity on a regular, continuous, and substantial basis. In general, rental activities, including rental real estate activities, are also passive activities even if you do materially participate. However, rental real estate activities in which you materially participate aren’t passive activities if you qualify as a real estate professional. Additionally, there’s a limited exception for rental real estate activities in which you actively participate. The rules for active participation are different from those for material participation. You can find guidelines for determining material participation, the rules for determining who’s a real estate professional and what’s active participation, and the special rules that apply to the income and losses from a passive activity held through a publicly traded partnership (PTP) in Publication 925, Passive Activity and At-Risk Rules.

Disposition of Entire Interest
Generally, you may deduct in full any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity.
In contrast, you may not claim unused passive activity credits merely because you disposed of your entire interest in the activity. However, you may elect to increase the basis of the credit property in an amount equal to the portion of the unused credit that previously reduced the basis of the credit property.
Where to Report
Use Form 8582 (PDF), Passive Activity Loss Limitations, to summarize income and losses from passive activities and to compute the deductible losses. Use Form 8582-CR (PDF), Passive Activity Credit Limitations, to summarize the credits from passive activities and to compute the allowed passive activity credit. You may also use Form 8582-CR to make an election to increase the basis of credit property when you dispose of the property.