A passive activity generally is a business activity in which you do not materially participate. The most common way to meet the material participation standard is to participate in the activity for at least 500 hours. You generally can deduct losses from passive activities only up to the amount of your gain from these activities. Two common passive activities are rental activities and investments in limited partnerships as a limited partner.
Passive losses in excess of passive income are carried to the following year (suspended) and are deductible only from passive income in the following year. Any losses not deductible in that year are carried forward again. Any suspended losses from a passive activity are deductible for the year in which the passive activity is sold in a fully taxable transaction to an unrelated taxpayer.
You may deduct up to $25,000 of losses from active-participation rental activities from non-passive income if you adjust gross income is less than $150,000.
There are two ways to increase your deduction for passive losses - invest in a business or rental property that produces passive income or sell a passive activity.
Promoters may try to interest you in a PIG - passive-income generator. These are investments, such as limited partnerships, designed to produce passive income to soak up passive losses. Be careful not to let your pursuit of tax savings lead you into a bad investment. Any investment touted as "tax-favored" around year-end - when many taxpayers are desperate for tax savings - begs for especially careful scrutiny. As explained above, disposition of a passive activity allows you to deduct all suspended losses from that activity.
The passive-loss rules are very complex. Be sure to discuss the tax consequences of passive activities with your tax advisor before you invest.
Return to Advice & Learning
