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Tax Tip of the Week | No. 435 | Passive Activity Losses November 29, 2017

Posted by bradstreetblogger in : Deductions, General, Tax Preparation, Tax Tip, Taxes, Uncategorized , trackback

Tax Tip of the Week | Nov 29, 2017 | No. 435 | Passive Activity Losses

Passive activity losses are also known as PAL’s. However, from a tax standpoint, they are anything but your PAL.

A passive activity is a business activity in which the taxpayer does not materially participate. There are seven tests for material participation, and you only need to pass one of the tests to be considered active. But most investors do not meet any of the tests.

Beginning in 1986, you may only deduct a passive activity loss to the extent you have passive activity income. A PAL cannot offset non-passive income or portfolio income.

The passive activity rules were passed by Congress in 1986 in an effort to limit the losses being deducted by many taxpayers through the use of tax shelters. Prior to enactment, taxpayers could invest in a myriad of limited partnership interests or other passive activities, most of which generated losses that the investors would deduct on their personal returns.

The passive activity rules prevented such deductions, causing many taxpayers to search for PIG’s (passive income generators). Those looking for PIG’s need to be cautious as to the type of investment they are buying. For instance, your broker might try to sell you an interest in a publicly traded partnership (PTP). However, these types of partnerships have their own set of rules, and might not be the PIG you were hoping for.

Rentals are another form of passive activity. Ordinary rental income or loss is passive by definition. Even if you are active in a rental activity, the net income or loss is still considered passive (assuming you are not a real estate professional). However, if certain conditions are met, a landlord can deduct up to $25,000 of rental loss on his or her return, even if there is no other passive income. Since net rental income is considered passive income, non-rental passive losses can be used to offset the income.

Any PAL limited by passive activity income is not lost but carried forward indefinitely, usually until the property is sold. In the year of sale, you can deduct the suspended loss, up to the amount of your basis in the activity.

You can contact us in Dayton at 937-436-3133 and in Xenia at 937-372-3504. Or visit our website.

This week’s author….Norman S. Hicks, CPA

…until next week.

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