For the most part, passive activities include rental activities and those trade or
business activities in which you do not materially participate. You materially participate
in an activity if you are involved on a regular, continuous, and substantial basis in the
operation of the activity. Rental real estate activities will not be passive activities if
you are a real estate professional and meet certain requirements. Guidelines for
determining material participation and the rules for a real estate professional can be
found in Publication 925, Passive Activity
and At-Risk Rules.
Generally, losses and credits from passive activities that exceed the income and tax
attributable to passive activities are disallowed. Use Form 8582, Passive Activity Loss Limitations,
to summarize income and losses from passive activities and to compute the deductible
losses. The disallowed losses and credits may be carried forward to the next tax year.
A special rule applies for passive rental real estate activities in which you actively
participate. The rules for active participation are different from those for material
participation and are discussed in Publication 925.
Passive losses are first offset against any passive income; any excess passive losses are
disallowed unless they arise from rental real estate. Up to $25,000 of additional passive
losses from rental real estate activities in which you actively participate may be used to
offset income from non-passive sources. This $25,000 amount is subject to a special
phase-out rule for individuals with an adjusted gross income in excess of $100,000. For
those who are married filing separately and who lived apart from their spouse the entire
year, the additional passive loss allowed is limited to $12,500 and the phase-out begins
at an adjusted gross income in excess of $50,000.
Generally, passive losses that have previously been disallowed are allowed in full in
the year the taxpayer disposes of the investment. However, unused passive credits are
lost. Publication 925 and Form 8582 can be ordered by calling
1-800-829-3676.
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