passive activity income

passive activity income

Income earned from a passive activity. The IRS segregates certain types of income and expenses so that passive activity expenses are deductible only from passive activity income.If expenses are greater than income,the taxpayer may not use additional deductions to shelter other income (such as regular payroll income), but must carry the losses forward and use them in a future year.As a general rule,there are two types of passive activities:

1. Trade or business activities in which the taxpayer does not materially participate (less than 500 hours, generally) during the year.

2. Rental activities, even if the taxpayer does participate in them, except for the following:

a. The taxpayer is a real estate professional.

b. The rental is a dwelling the taxpayer uses for more than 14 days per year or 10 percent of the days the dwelling was available for rental, whichever is greater.

c. Taxpayers may deduct up to $12,500 in losses ($25,000 if married) from passive activi- ties if they or their spouse actively participated in it. There is a phaseout for various income levels.

d. Low-income housing credits are available up to a maximum of $25,000.

(The rules are extremely complicated, and there are many exceptions. For further information see Publication 925:“Passive Activity and At-Risk Rules” and Tax Topics 425:“Passive Activities—Losses and Credits”at the IRS Web site

The Complete Real Estate Encyclopedia by Denise L. Evans, JD & O. William Evans, JD. Copyright © 2007 by The McGraw-Hill Companies, Inc.
References in periodicals archive ?
J will treat $2,500 (50% x $5,000) of his interest income on the loan to A as passive activity income. This represents J's interest income ($5,000) multiplied by his share of the LLC's passive interest expense from all member loans ($2,500) divided by the greater of (1) J's share of A's interest expense on all member loans used for passive activities or otherwise ($2,500), or (2) J's interest income from A ($5,000).
This passive activity income from Property B can be offset by the $6,400 loss from Property A, so Brett reports a taxable profit of only a net $1,100.
Interest, capital gains, dividends, annuities, passive activity income and rental income are all considered investment income.
Taxpayers may only deduct passive activity losses to the extent they receive passive activity income. In addition, any excess loss can be carried forward to offset passive income in future years, or taxpayers may choose to deduct the loss when the property is sold in a fully taxable transaction.
Because IRC section 1411(c)(2) treats passive activity income as net investment income, such income will be exposed to the Medicare contribution tax.
Certain income and expenses of a passive activity are not considered passive activity income or expenses in determining passive activity income and loss: income from interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business; expenses allocable to such income; and gain or loss not derived in the ordinary course of a trade or business that is attributable to the disposition of property either producing such income or held for investment.
In general, losses from passive activities are deductible in a given year to the extent the passive activity income exceeds the losses from passive activities.
IRC section 469 states that a taxpayer can use losses from a passive activity only to offset passive activity income. In other words, passive losses cannot shelter active income such as salaries, commissions, wages or portfolio income such as interest, dividend or annuity income.
Considerations include the size of the interest payments, the amount of rental income received from the property, the availability of other passive activity income, and, of course, the taxpayer's AGI.
That means that any loss attributable to rental real estate - whether it's derived from a cash loss via a poor marketplace, or whether it's a `phantom loss' generated primarily through depreciation - falls into the passive category and can only be offset against passive activity income. The Tax Act thereby created a disincentive for putting money into property.
* Passive activity credits are not affected by the disposition of the activity and remain suspended until they can offset tax attributable to passive activity income.