Federal Tax

Passive Loss Rules (Portfolio 549)

  • The Portfolio, Passive Loss Rules, describes in detail the application of the passive loss rules to losses and credits from investments in passive activities.

Description

Bloomberg Tax Portfolio, Passive Loss Rules, No. 549, describes in detail the application of the passive loss rules to losses and credits from investments in passive activities. In general, the passive loss rules limit the deduction of net losses from passive activities and the use of credits from such activities to offset tax liability on income that is not from such activities. These rules, which apply generally to all non-corporate taxpayers (and personal service corporations and closely held C corporations), treat portfolio income (e.g., dividends and interest not derived in the ordinary course of business) as income not derived from a passive activity.

In general, passive activities under the rules are those activities involving the conduct of a trade or business in which the taxpayer does not materially participate. Material participation requires regular, continuous, and substantial involvement by the taxpayer in the operations of the activity — a relatively high standard that requires considerably more than general management responsibility. All rental activities are treated as per se passive, except for interests in rental real estate owned by certain real estate operators. Except as provided in regulations, no interest as a limited partner is treated as an interest with respect to which the taxpayer materially participates.

Deductions and credits from passive activities that are disallowed for any year, because in excess of income and tax liability attributable to all such activities, are suspended and carried forward indefinitely to be used against passive income arising in a subsequent taxable year. Suspended passive losses are allowed against nonpassive income upon the disposition of the taxpayer’s entire interest in the activity, or in limited cases upon a partial disposition. Certain losses and credits from rental real estate activities may also be allowed against nonpassive income and tax liability, up to a maximum of $25,000 per year.

Table of Contents

I. Overview
II. Taxpayers Subject to the Passive Loss Rules
III. Identifying Passive Activities
IV. Treatment of Particular Items
V. Allowance of Passive Losses and Credits Against Nonpassive Income and Tax Liability
VI. Interaction of Passive Loss Rules with Other Code Provisions

Daniel-Shaviro
Daniel Shaviro
Professor Of Law
New York University School Of Law
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