Chapter 10

Loss Restrictions: Passive Activities and At-Risk Limits

The passive activity laws were intended to discourage tax-shelter investments, but their reach goes beyond tax shelters to cover all real estate investors and persons who invest in businesses as “silent partners” or who are not involved full time in the business. The passive activity rules prevent an investor from deducting what the law defines as a passive loss from salary, self-employment income, interest, dividends, sales of investment property, or retirement income. Such losses are deductible only from income from other passive activities. Losses disallowed by the passive activity rules are suspended and carried forward to later taxable years and become deductible only when passive income is realized or substantially all of the activity is sold.

Casualty and theft losses are not passive losses unless they are of the type usually occurring in a business, such as shoplifting theft losses.

On your tax return, passive income items and allowable deductible items are reported as regular income and deductions. For example, rental income and allowable deductions are reported on Schedule E. However, before you make these entries, you may have to prepare Form 8582, which identifies your passive income and losses and helps you to determine whether passive loss items are deductible.

At-risk rules generally limit losses for an activity to your cash investment and loans for which you are personally liable, as well as certain nonrecourse financing for real estate investments. See 10.17.

10.1 Rental Activities

10.2 Rental Real Estate Loss Allowance of up to $25,000

10.3 Real Estate Professionals

10.4 Participation May Avoid Passive Loss Restrictions

10.5 Classifying Business Activities as One or Several

10.6 Material Participation Tests for Business

10.7 Tax Credits of Passive Activities Limited

10.8 Determining Passive or Nonpassive Income and Loss

10.9 Passive Income Recharacterized as Nonpassive Income

10.10 Working Interests in Oil and Gas Wells

10.11 Partners and Members of LLCs and LLPs

10.12 Form 8582

10.13 Suspended Losses Allowed on Disposition of Your Interest

10.14 Suspended Tax Credits

10.15 Personal Service and Closely Held Corporations

10.16 Sales of Property and of Passive Activity Interests

10.17 At-Risk Limits

10.18 What Is At Risk?

10.19 Amounts Not At Risk

10.20 At-Risk Investment in Several Activities

10.21 Carryover of Disallowed Losses

10.22 Recapture of Losses Where At Risk Is Less Than Zero