Passive Business Activity
Internal Revenue Code Section 469
The passive activity loss rules have developed into a complicated set of guidelines since their inception. If you keep in mind the and have a general understanding of the principles that drive loss limitations in this area, you will have a good foundation for selecting investment strategies that allow you to take full advantage of the passive activity rules.
Here is a basic breakdown of the rules and how they may relate to you.
What is a passive activity?
A passive activity means the taxpayer doesnot materially participate. The Test can either be a 100 or 500 hour annual analysis. Any rental activity is a passive activity whether or not the taxpayer materially participates.
Generally, losses from passive activities may not be deducted from other active types of income (for example, wages, interest, or dividends, which is considered active or portfolio.) These losses are suspended and carried forward as a deduction from any passive activity in the next succeeding tax year. Any unused suspended losses are allowed in full when the taxpayer disposes of the enire interest in the activity in a fully taxable transaction.
What is Material Participation?
To be considered as materially participating in an activity an individual must satisfy any of the following tests:
- Participation of more than 500 hours
- The participation constitutes substantially all of the participation in the activity
- The participation is for more than 100 hours and this participation is not less than the participation of any other individual
- The activity is a "significant participation activity" and this participation in all such activities exceeds 500 hours Materially participating in the activity for any five years of the 10 years that preceded the year in question
- The activity is a "personal service activity" and there is material participation in the activity for any three years preceding the tax year in question
- Facts and circumstances tests are satisfied, which require proof of regular participation on a continuous and substantial basis
How are these losses deducted?
A loss arising from a passive activity is deductible against the net income of another passive activity. Losses that are not deductible for any particular tax year because there is insufficient passive activity income to offset them (suspended losses) are carried forward indefinitely and are allowed as deductions against passive income in subsequent years. Unused suspended losses are allowed in full upon a fully taxable disposition of the taxpayer's entire interest in the activity.
There are also special rules for real estate rental activities and real estate professionals. If you would like to know more about this topic and would like to discuss this further, please feel free to contact our office.
Ralph Anderson - firstname.lastname@example.org
Maria DeGennaro - email@example.com
Pursuant to IRS Circular 230 regulation: "Any tax advice expressed was not intended or written to be used, and cannot be used, by any taxpayer, for the purpose of avoiding penalties that may be imposed on the taxpayer. If this advice was written to support the promotion or marketing of partnership or other entity, investment plan, or arrangement to any taxpayer then the advice was written to support the promotion or marketing of the matters addressed by the written advice and the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax adviser"