As is often times the case, a passive activity is any business activity in which the tax payer is not an active participant, for example, real estate rental activity in which the owner is not actively engaged for a set amount of time per year.
Non-passive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, or investment income.
The passive activity loss rules are applied at the individual level but its impact extends to virtually every business or rental activity whether reported on Schedules C, F, or E, as well as to flow through income and losses from partnerships, S- Corporations, and trusts.
As a generally rule the law does not apply to regular C-Corporations but it does have limited application to closely held corporations. Passive activities can be categorized as either:
1) Rental activity – both equipment and real estate rentals
2) Business activity – businesses in which there is not a material participation on a regular or continuous basis by the taxpayer
On a tax return, income can be categorized as being derived from either a passive or non-passive activity involvement. Passive activity income are those incomes derived without any material participation in the activity undertaken. In the case of a partnership, a limited partner’s income is considered passive as there is no material participation on his part.
The important point to note is that the level of participation is the key determining factor for the income categorization as passive as opposed to active income.
However, it is to be noted that rental activity is deemed a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional. The rule applies to all individuals, estates and trusts, personal service corporations and even to closely held corporations. The rule is also applicable to owners of partnerships, s corporations and grantor trusts.
By definition your passive activity loss for the tax year is the excess of all passive activity deductions over all passive activity income. These losses are generally not allowed but there is a special allowance under which some or all of your passive activity loss may be allowed.
The CPAs at Metro Accounting And Tax Services will be happy to show how this is possible. Call the office today 470-240-5143.
User | 1/11/2017