Passive activities include trade or business activities (in which you do not materially participate) and rental activities. You materially participate in an activity if you are involved in the operation of the activity on a regular, continuous, and substantial basis. Rental real estate activities are not 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 income tax attributable to passive activities are disallowed, but carried forward. A similar rule applies to credits from passive activities.

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 phased out for individuals with a modified 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 a modified adjusted gross income in excess of $50,000.

Use Form 8582, Passive Activity Loss Limitations, to summarize income and losses from passive activities and to compute the deductible losses. Use Form 8582-CR to report passive activity credit limitations.

Generally, passive losses that have previously been disallowed can be deducted in full in the year the taxpayer disposes of the activity. Unused passive activity credits may not be deducted upon disposition of the activity but an election can be made to increase the basis of the credit property. Publications and forms may be downloaded from this site or ordered by calling 1-800-829-3676.

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