{"id":15097,"date":"2020-10-30T14:21:01","date_gmt":"2020-10-30T19:21:01","guid":{"rendered":"https:\/\/sfwpartnersllc.com\/?p=15097"},"modified":"2020-10-30T14:21:01","modified_gmt":"2020-10-30T19:21:01","slug":"understanding-the-passive-activity-loss-rules","status":"publish","type":"post","link":"https:\/\/www.sfw.cpa\/news-and-guides\/understanding-the-passive-activity-loss-rules\/","title":{"rendered":"Understanding the Passive Activity Loss Rules"},"content":{"rendered":"

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Are you wondering if the passive activity loss rules affect business ventures you\u2019re engaged in \u2014 or might engage in?<\/p>\n

If the ventures are passive activities, the passive activity loss rules prevent you from deducting expenses that are generated by them in excess of their income. You can\u2019t deduct the excess expenses (losses) against earned income or against other nonpassive income. Nonpassive income for this purpose includes interest, dividends, annuities, royalties, gains and losses from most property dispositions, and income from certain oil and gas property interests. So you can\u2019t deduct passive losses against those income items either.<\/p>\n

Any losses that you can\u2019t use aren\u2019t lost. Instead, they\u2019re carried forward, indefinitely, to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity aren\u2019t used up in this way, you\u2019ll be allowed to use them in the tax year in which you dispose of your interest in the activity in a fully taxable transaction, or in the tax year you die.<\/p>\n

Passive vs. material<\/strong><\/p>\n

Passive activities are trades, businesses or income-producing activities in which you don\u2019t \u201cmaterially participate.\u201d The passive activity loss rules also apply to any items passed through to you by partnerships in which you\u2019re a partner, or by S corporations in which you\u2019re a shareholder. This means that any losses passed through to you by partnerships or S corporations will be treated as passive, unless the activities aren\u2019t passive for you.<\/p>\n

For example, let\u2019s say that in addition to your regular professional job, you\u2019re a limited partner in a partnership that cleans offices. Or perhaps you\u2019re a shareholder in an S corp that operates a manufacturing business (but you don\u2019t participate in the operations).<\/p>\n

If you don\u2019t materially participate in the partnership or S corporation, those activities are passive. On the other hand, if you \u201cmaterially participate,\u201d the activities aren\u2019t passive (except for rental activities, discussed below), and the passive activity rules won\u2019t apply to the losses. To materially participate, you must be involved in the operations on a regular, continuous and substantial basis.<\/p>\n

The IRS uses several tests to establish material participation. Under the most frequently used test, you\u2019re treated as materially participating in an activity if you participate in it for more than 500 hours in the tax year. While other tests require fewer hours, all the tests require you to establish how you participated and the amount of time spent. You can establish this by any reasonable means such as contemporaneous appointment books, calendars, time reports or logs.<\/p>\n

Rental activities<\/strong><\/p>\n

Rental activities are automatically treated as passive, regardless of your participation. This means that, even if you materially participate in them, you can\u2019t deduct the losses against your earned income, interest, dividends, etc. There are two important exceptions:<\/p>\n