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Need Some Deductions for 2011?
Don't overlook these!
Updated for 2011
Passive Activity Rules
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Passive Income and Losses
If you do not meet at least one of the material participation tests for the activity each tax year, income or loss passed through to you from the activity in which you have an ownership interest is classified as passive.
However, if you do meet any one of these tests, then, income or loss passed through to you is classified as nonpassive. Nonpassive losses are not subject to the passive activity rules.
Passive losses:
Passive losses are only deductible up to passive income.
Suspended losses:
Passive losses that exceed passive income in any given year are not deductible in that year and are called suspended losses. You may carry suspended losses forward indefinitely.
A suspended loss may be deducted when you have sufficient passive income or you dispose of the activity.
Losses from an activity in which you materially participate, although not subject to the the passive activity rules, are subject to the at-risk rules.
Example:
Passive loss and nonpassive income.
- You invest in Company T but do not participate in its operations (you're a passive investor).
- You invest in Company X, in which you do materially participate.
- You have no investment in any other activities.
- Company T has a loss of which your share is $5,000. It is a passive loss.
- Company X has a profit of which your share is $2,000. It is nonpassive income.
Result:
In this example, you have the following situation:
- A passive loss
- A suspended loss
- A nonpassive loss
1) Passive loss:
- You CANNOT deduct any of the $2,000 loss in the current year.
- The $2,000 loss is a passive loss, however, you have no passive income to offset it against.
- Therefore, since it is not deductible in the current year it is a suspended loss.
2) Suspended loss:
- You may carry a suspended loss over to the following year or other future years indefinitely, until you either have passive income to offset the loss against or you dispose of the activity.
- You can deduct any remaining suspended loss when you dispose of the activity.
Reminder: Don't forget to keep tract of suspended losses! You don't want to overlook deducting a suspended loss from passive income of a future tax year. To remind you, staple a note to the front of the tax return for the year the suspended loss was originally created. Then, when you retrieve that return to prepare your current year return you'll be reminded.
Nonpassive income:
- You have nonpassive income of $2,000.
- It must be included in your gross income.
- Enter the $2,000 on Schedule E, Part II in the Nonpassive Income and Loss section (located to the right of the passive income and loss section).
- Carry the $2,000 from Schedule E to the front of Form 1040.
Example:
Passive loss limited to passive income.
- You invest in two companies: Company A and Company B.
- You do not materially participate in either of them.
- Therefore, they are passive activities and any income or loss you derive from these activities is passive income or loss.
- Company A has a loss of which your share is $10,000 (a passive loss).
- Company B has a net profit of which your share is $6,000 (passive income).
Result:
In this example, you have the following situation:
- Passive income
- A passive loss
- A suspended loss
Passive losses may only be deducted from passive income.
1) Passive income:
- You have passive income from Company B of $6,000.
2) Passive loss ($6,000 is deductible)
- Since your passive income is only $6,000, you can only deduct $6,000 of the $10,000 passive loss.
- The remaining $4,000 is a suspended loss.
3) Suspended loss
- Your excess loss of $4,000 is a suspended loss.
- You may carry a suspended loss over to the following year or other future years indefinitely, until you either have passive income to offset the loss against or you dispose of the activity.
- You can deduct any remaining suspended loss when you dispose of the activity.
Next:
Passive Activity Rules: Rental Real Estate; Special $25,000 Allowance for Real Estate Nonprofessionals
Related Links
- Passive Activity and At-Risk Rules
- Who Do Passive Activity Rules Apply To
- Investors
- Purpose of Passive Activity Rules
- What is a Passive Activity?
- Tax Forms You May Need to File
- Material Participation
- Proof of Participation
- Qualifying for Material Participation
- Seven Material Participation Tests
- Significant Participation Passive Activities
- Portfolio Income
- Portfolio Income and Passive Losses
- Interest on Accounts Receivable
- What are At-Risk Rules?
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