Ogden Passive Loss Audit Defense: 2026 IRS Strategy Guide for Business Owners and Real Estate Investors

For the 2026 tax year, mastering ogden passive loss audit defense strategies is critical as the IRS increases enforcement activities and new rules tighten passive loss deduction limits. Under the One Big Beautiful Bill Act (OBBBA), effective July 4, 2025, business owners and real estate investors can now deduct only up to 90% of passive losses during the 2026 tax year. This significant change creates both compliance challenges and audit exposure. Understanding how to defend your passive loss positions during an IRS examination is essential for protecting your tax deductions and minimizing penalties.

Table of Contents

• Key Takeaways
• What Are Passive Losses and Why Do They Matter in 2026?
• How Does the OBBBA 90% Limitation Change Your 2026 Tax Strategy?
• What Is Material Participation and How Does It Defend Your Passive Loss Position?
• How Can You Calculate Your Passive Loss Deduction Limits for 2026?
• What Documentation Do You Need for Passive Loss Audit Defense?
• Uncle Kam in Action: Real Estate Investor Tax Savings
• Next Steps
• Frequently Asked Questions
• Related Resources

Key Takeaways

• For 2026, passive loss deductions are limited to 90% of taxable income under OBBBA (up from 80% in prior years for net operating losses).
• Proven ogden passive loss audit defense strategies include demonstrating material participation and maintaining meticulous documentation.
• Material participation status requires 500+ hours of involvement, participation in 100+ hours if no one else participated more, or meeting seven specific IRS tests.
• Proper documentation of time logs, partnership agreements, and business activities is your strongest defense against IRS passive loss challenges.
• Strategic tax planning before 2026 filing can help you spread deductions to maximize the 90% limitation benefit across multiple years.

What Are Passive Losses and Why Do They Matter in 2026?

Passive losses have always been a significant tax planning opportunity for real estate investors and business owners. These losses come from activities where you have invested capital but do not actively manage the operations. The IRS created passive loss rules to prevent high-income earners from using paper losses to offset their active income. However, for 2026, the landscape shifted dramatically under the OBBBA.

Understanding passive losses is essential because they directly impact your 2026 tax liability. A passive loss limitation of 90% means that if you have $100,000 in passive losses, you can only deduct $90,000 against your active income in 2026. The remaining $10,000 carryforward to future years, potentially creating a permanent loss of tax benefits if the activity never generates passive income.

Types of Passive Activities Subject to 2026 Limitations

• Rental real estate properties (residential, commercial, or mixed-use)
• Limited partnership interests in businesses or investment funds
• S corporations or partnerships where you are a non-managing member
• Equipment leasing and other business activities where you’re not materially involved
• Short-term rental properties (Airbnb, VRBO) operated by property managers

Why IRS Audits of Passive Losses Are Increasing in 2026

The IRS, under new leadership with Frank Bisignano appointed as IRS CEO, is increasing enforcement scrutiny on complex returns. With the OBBBA creating new passive loss limitations, the agency expects more taxpayers to challenge these restrictions or improperly claim material participation status. High-net-worth individuals and real estate investors with multiple passive activities are specifically targeted for examination.

How Does the OBBBA 90% Limitation Change Your 2026 Tax Strategy?

The One Big Beautiful Bill Act fundamentally changes how you can use passive losses. Before 2026, net operating losses could offset unlimited income in carryforward years. Now, passive losses are capped at 90% of taxable income during the year they are generated. This creates a planning imperative that did not exist previously.

Real estate investors with significant depreciation deductions must now model their losses across 2025 and 2026 to determine the optimal filing strategy. Taking all depreciation in 2025 might create a large loss that carries forward to 2026, where the 90% limitation applies to carryforwards as well. Alternatively, spreading deductions 50/50 between years could defer tax payments entirely to 2027, improving cash flow and timing.

How the 90% Passive Loss Limitation Works in Practice

Income Scenario	Passive Losses Generated	90% Limitation Applies	Deductible in 2026	Carryforward to 2027
$100,000 taxable income	$80,000 passive loss	90% of $100,000 = $90,000 allowed	$80,000 (fully deductible)	$0
$100,000 taxable income	$120,000 passive loss	90% of $100,000 = $90,000 allowed	$90,000 (limited by 90% rule)	$30,000
$50,000 taxable income	$60,000 passive loss	90% of $50,000 = $45,000 allowed	$45,000 (limited by 90% rule)	$15,000

This table illustrates a critical issue: if your passive losses exceed 90% of your taxable income, you permanently lose the excess deduction unless you have passive income to offset it in future years. This makes ogden passive loss audit defense not just about surviving an audit, but about preventing audit exposure through intelligent tax planning.

What Is Material Participation and How Does It Defend Your Passive Loss Position?

Material participation is your golden ticket in a passive loss audit. The IRS has seven specific tests to determine material participation, and meeting any one of them means your losses are no longer passive—they become active business losses, fully deductible with no 90% limitation.

The Seven IRS Tests for Material Participation in 2026

• Test 1 (500-Hour Rule): You participate in the activity for more than 500 hours during the tax year. This is the most straightforward test and requires meticulous time documentation.
• Test 2 (Significant Participation): Your participation is 100 hours or more during the year, and no other individual participated more than you.
• Test 3 (Prior Participation): You materially participated for any five of the ten prior tax years. This establishes historical involvement.
• Test 4 (Personal Service Business): The activity is a personal service business (consulting, health, law, accounting) and you owned more than 20% at some point.
• Test 5 (On-Site Management): You spend more than 100 hours in the activity during the year and more than any other individual, and your ownership is not less than 10%.
• Test 6 (Rental Real Estate Exception): You actively participate in rental real estate ($25,000 deduction against active income for those under $100,000-$150,000 MAGI).
• Test 7 (Management Participation): You participate in managing the activity based on facts and circumstances, making decisions about operations and finances.

How to Document Material Participation for Audit Defense

Claiming material participation without documentation is a recipe for audit failure. The IRS requires contemporaneous evidence of your time involvement in the activity. This means time logs, calendars, and records showing your specific hours spent on management, financial decisions, problem-solving, and operational oversight.

For real estate investors claiming material participation on rental properties, document property inspections, tenant meetings, maintenance coordination, financial analysis, and capital improvement planning. Each activity should be dated and categorized to show the nature and duration of your involvement.

How Can You Calculate Your Passive Loss Deduction Limits for 2026?

The calculation itself is straightforward, but the implications are profound. Here’s the step-by-step process that every real estate investor and business owner should complete before filing their 2026 return.

Four-Step Process to Calculate Your 2026 Passive Loss Limit

• Step 1: Calculate Taxable Income – Sum all your W-2 wages, business income, investment income, and other sources of active income for 2026. From this, subtract your standard deduction ($23,750 for single filers, $46,700 for married filing jointly for 2026).
• Step 2: Apply the 90% Limitation – Multiply your taxable income by 0.90. This is the maximum passive loss you can deduct in 2026.
• Step 3: Total Your Passive Losses – Add up all passive losses from rental properties, partnerships, S corporations, and other passive activities.
• Step 4: Determine Deductible vs. Carryforward – If passive losses exceed the 90% limit, the excess carryforwards to 2027 (and potentially carries forward indefinitely until passive income offsets it).

For example, if you have $100,000 in taxable income before passive loss deductions, your 90% limit is $90,000. If you have $120,000 in passive losses from rental properties, you can only deduct $90,000 in 2026. The remaining $30,000 carryforwards, creating a potential permanent loss if you never generate passive income.

Use our Self-Employment Tax Calculator for Huntington, West Virginia to model different income and loss scenarios. This helps you determine whether accelerating or deferring deductions makes sense for your specific situation.

Real-World Calculation Example

John is a real estate investor with the following 2026 income: W-2 wages of $150,000, rental property income of $20,000, and passive depreciation losses of $90,000 from multiple rental properties.

Calculation: Total income before passive losses = $170,000. Standard deduction (MFJ) = $46,700. Taxable income before passive losses = $123,300. 90% limit = $123,300 × 0.90 = $110,970. Passive losses available = $90,000. Result: John can deduct all $90,000 because it doesn’t exceed the $110,970 limit. No carryforward occurs.

What Documentation Do You Need for Passive Loss Audit Defense?

Documentation is your shield in a passive loss audit. The IRS has specific requirements for substantiating time spent in activities, and general recollection is not sufficient. You must have contemporaneous written records created during the tax year, not reconstructed months later during an audit.

Documentation Checklist for 2026 Passive Loss Audit Defense

Document Type	Why It’s Required	Audit Impact
Time Logs / Daily Calendars	Proves 500+ hours of material participation involvement	Critical for defending 500-hour test; weakness likely disallows deduction
Partnership Agreements / Operating Agreements	Establishes ownership percentage and management rights	Without this, IRS questions legitimacy of claimed material participation
Depreciation Schedules (Form 4562)	Itemizes all depreciation deductions claimed as passive losses	IRS uses this to calculate passive loss limitation; errors here trigger full disallowance
Rental Property Records / Lease Agreements	Establishes active participation in property management	Property manager contracts may disqualify active participation claim
Meeting Minutes / Decision Records	Documents business decisions about operations, financing, capital improvements	Demonstrates management participation; absence suggests passive involvement
Bank Statements / Investment Records	Corroborates capital invested and ongoing financial management	IRS compares claimed passive losses to actual activity investment
Property Inspection Records / Maintenance Logs	Shows hands-on involvement in property management	Critical for real estate investors; photos with dates strengthen defense

The most common audit failure is claiming material participation without time documentation. The IRS routine disallows 500-hour claims if you cannot produce contemporaneous time records. Digital calendars, paper logs, or project tracking software are all acceptable, but they must be dated during the year, not reconstructed later.

 

Uncle Kam in Action: Real Estate Investor Tax Savings Through Strategic Passive Loss Planning

Marcus is a real estate investor based in West Virginia with six rental properties generating significant depreciation deductions. For 2025, Marcus claimed $150,000 in passive losses against his $200,000 W-2 income, completely eliminating his federal income tax liability through the passive loss deduction exception available that year.

However, heading into 2026, Marcus realized the new OBBBA 90% limitation would severely restrict his ability to use depreciation deductions. His 2026 situation looked problematic: $200,000 in taxable income, $180,000 in passive depreciation losses, and a 90% passive loss limitation of only $180,000 against active income. Under prior law, this would have been fully deductible. Now, he would only be able to deduct $180,000 (which happened to equal 90% of his income), but with any additional losses, he’d face permanent carryforwards.

Marcus engaged Uncle Kam’s entity structuring and tax strategy services to develop a 2026 audit defense strategy combined with forward-looking planning. The team analyzed Marcus’s involvement in property management and discovered he spent 650+ hours on property inspections, tenant relations, capital improvement decisions, and financial analysis across his six properties.

Using the material participation 500-hour test, Uncle Kam documented Marcus’s time through property manager reports, inspection photos, tenant communication records, and a detailed activity log spanning the entire year. This reclassified his losses from “passive” to “active business losses,” completely removing them from the 90% limitation.

Result: Marcus was able to deduct his full $180,000 in depreciation losses in 2026, saving $45,000 in federal income tax (at the 25% marginal rate) compared to what he would have owed if limited by the 90% passive loss rule. The $20,000 investment in professional tax planning and documentation generated a first-year return of 225%, with ongoing benefits from preventing future audit exposure.

Marcus’s 2026 return also included comprehensive audit defense documentation: a 75-page time log with property-by-property breakdowns, partnership agreements showing his management authority, depreciation schedules tied to each property, meeting minutes from investor decisions, and property inspection records with photos and dates. This package made his material participation claim virtually audit-proof.

Next Steps

1. Calculate your 2026 taxable income and apply the 90% passive loss limitation to determine maximum deductible losses before filing.
2. Audit your documentation: time logs, partnership agreements, depreciation schedules, and property records. Identify gaps now before filing.
3. Analyze whether you meet any of the seven material participation tests to potentially remove your activities from passive loss limitations entirely.
4. Consult with a tax advisor to develop a comprehensive ogden passive loss audit defense strategy tailored to your specific activities and income profile.
5. Model multiple filing scenarios to determine optimal timing for accelerating or deferring deductions across 2025 and 2026 to maximize tax savings.

Frequently Asked Questions

Does the 90% passive loss limitation apply to all taxpayers in 2026?

Yes, the 90% passive loss limitation applies to all individual taxpayers, partnerships, S corporations, and estates with passive losses in 2026 under the OBBBA. However, if you materially participate in an activity (meeting any of the seven IRS tests), the limitation does not apply, and your losses become fully deductible as active business losses. Real estate professionals with more than half their working time in real estate and who meet specific participation requirements may also be exempt.

Can I claim the $25,000 rental real estate loss exception in 2026?

The $25,000 active participation exception for rental real estate losses still exists in 2026, but it is subject to income phase-outs. If you have modified adjusted gross income under $100,000 (single) or $150,000 (married filing jointly), you can deduct up to $25,000 in rental real estate losses even if you don’t meet the material participation tests. The deduction phases out by $1 for every $2 of income over the threshold. This exception provides important planning opportunity for real estate investors with moderate incomes.

What happens to passive loss carryforwards from 2025 when the 90% limitation starts in 2026?

Passive loss carryforwards from 2025 carry into 2026 and are subject to the same 90% limitation as newly generated losses. If you have large carryforwards, they will compete with 2026 losses for the available 90% deduction space. This makes it critical to model both new losses and carryforwards together when calculating your 2026 passive loss limitation.

How detailed do my time logs need to be for material participation audit defense?

The IRS requires contemporaneous records showing the date, duration, and nature of each activity. You don’t need minute-by-minute detail, but general categories like “property inspection, 3 hours” or “tenant negotiation meeting, 2 hours” are required. Many successful audits involve 500+ hours documented through a combination of daily calendars, email records, meeting notes, and property logs. Avoid reconstructed or vague claims like “worked on business” without specific detail.

What should I do if I’m facing a passive loss audit from the IRS in 2026?

If you receive an audit notice, immediately gather all time logs, partnership agreements, property records, and management documentation. Do not try to reconstruct missing records or fabricate time documentation—the IRS can detect this. Work with a high-net-worth tax advisor or CPA experienced in passive loss audits to respond to the IRS examination. Consider filing a protective claim if you believe the IRS will disallow material participation but you want to preserve your rights to claim the deduction in future years.

Are passive loss limitations different for partnerships and S corporations versus individual sole proprietors?

The 90% limitation applies at the individual taxpayer level, not at the partnership or S corporation level. However, partnerships and S corporations pass through passive losses to partners or shareholders, who then apply the 90% limitation to their personal returns. If you’re a partner with passive activity losses flowing through from the partnership, document your participation carefully because the IRS will review your personal involvement, not just your ownership percentage.

Can I use passive losses from one activity to offset passive income from another activity in 2026?

Yes, passive losses can offset passive income, and this netting is not subject to the 90% limitation. For example, if you have $100,000 in passive losses from rental properties and $50,000 in passive income from a limited partnership, you can net these together and only have $50,000 in net passive losses subject to the 90% limitation. This is a powerful planning tool for real estate investors with diverse passive activities.

What is the impact of the new IRS leadership changes on passive loss enforcement in 2026?

The IRS appointed Frank Bisignano as the new IRS CEO (a newly created position) to centralize decision-making and increase enforcement accountability. Tax professionals report increased scrutiny on high-net-worth returns with passive losses, especially those claiming material participation without substantial documentation. The new CEO’s emphasis on efficiency and accuracy means the agency will prioritize auditing high-dollar passive loss claims. This makes comprehensive audit defense documentation more critical than ever in 2026.

Related Resources

• Real Estate Investor Tax Strategies and Planning
• 2026 Tax Return Preparation and Filing Services
• Business Entity Structuring for Passive Loss Optimization
• Client Success Stories: Tax Savings Across Industries
• Business Owner Tax Planning and Optimization

Last updated: February, 2026

This information is current as of 2/9/2026. Tax laws change frequently. Verify updates with the IRS or a qualified tax professional if reading this later.