Passive Activity Losses - Uncle Fed's Tax*Board

• On an entire disposition to an unrelated party in a fully taxable transaction,
both current and suspended losses may be deducted against wages,
portfolio income and other non-passive income [6] . See Chapter 5.
• Rental real estate losses up to $25,000 may be deducted by an individual
whose modified adjusted gross income (MAGI) is less than $100,000 [7] .
To qualify for this offset, the taxpayer must actively participate, own at
least 10 percent and not be a limited partner. The $25,000 exception is
phased out at the rate of 50 cents for every dollar of MAGI over $100,000.
Therefore, when MAGI exceeds $150,000, the $25,000 offset is not
allowed. See Chapter 2.
Beginning in 1994, a real estate professional may be able to deduct all current
rental real estate losses regardless of how high his MAGI might be [8] . To deduct
losses without limit, the taxpayer must spend more than half of his time in real
property businesses and work more tha n 750 hours a year and materially
participate in each separate rental real estate activity. Again, see Chapter 2.
Disallowed passive losses can be carried forward indefinitely [9] until there is
passive income or an entire disposition in a fully taxable transaction. Net gain on
the sale of a passive activity is generally passive income, which can be offset by
unrelated passive losses. See Chapter 5.
Participation Rules
There are two distinct types of participation:
• Material participation; and,
• Active participation.
Material participation generally applies to business activities. The IRC §
469(h)(1) provides that if the taxpayer works on a regular, continuous, and
substantial basis in operations, his losses are non-passive, i.e. deductible in full.
There are seven tests [10] discussed in Chapter 5.
Active participation [11] relates only to rental real estate activities and is a less
stringent standard than material participation. If the taxpayer makes
management decisions, he generally can deduct up to $25,000 in losses against
non-passive income, subject to the $150,000 MAGI limitation. See exhibit at end
of Chapter 2 .
Neither the material participation standard nor the active participation standard
generally applies to long-term equipment rentals. Equipment leasing losses are
generally passive regardless of the level of participation [12] . Thus, equipment
leasing losses are generally not deductible unless the taxpayer has passive
income from other sources.
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