In general, you can deduct passive activity losses only from passive activity income. You carry any excess loss forward to the following year or years until used, or until deducted in the year you dispose of your entire interest in the activity in a fully taxable transaction. The passive activity rules apply to individuals, estates, trusts (other than grantor trusts), personal service corporations, and closely held corporations. Even though the rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities.
There are two kinds of passive activities:
- Trade or business activities in which you do not materially participate during the year, and
- Rental activities.
A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a Real Estate Professional.
An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers, and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property. It does not matter whether the use is under a lease, a service contract, or some other arrangement.
Your activity is not a rental activity if:
- The average period of customer use of the property is seven days or less,
- The average period of customer use of the property is 30 days or less and you provide significant personal services with the rentals;
- You provide extraordinary personal services in making the rental property available for customer use;
- The rental is incidental to a nonrental activity;
- You customarily make the rental property available during defined business hours for nonexclusive use by various customers; or
- You provide the property for use in a nonrental activity in your capacity as an owner of an interest in the partnership, S corporation, or joint venture conducting that activity.
If you or your spouse actively participated in a passive rental real estate activity, you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities. Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception. If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income. The maximum special allowance is reduced if your modified adjusted gross income exceeds certain amounts.
Please contact the office of Don Fitch Accountancy at (760)567-3110 or Email Don.Fitch@CPA.com if you have any questions or would like additional information.
DON FITCH, CPA
74478 Highway 111 #3
Palm Desert, CA 92260
Toll Free: (877)CPA-Help or (877)272-4357