What is a passive activity loss? This can be a common question when individuals invest as a passive investor or perhaps for individuals that own and rent real estate. Your passive activity loss is would generally be to the extent your passive activity deduction exceed passive activity gross income. Moreover, this passive activity loss will generally be disallowed, although some exceptions such as the $25,000 special allowance for passive real estate activity are allowed.
So what happens when your passive deductions exceed your passive income and you have a passive loss? How are your disallowed passive losses allocated? When all of your passive losses or part of your passive losses are disallowed for the tax year, a ratable portion of the loss from each of the passive activities is disallowed. This ratable portion of your passive losses will be calculated by multiplying the passive activity losses that are disallowed for the year by the fraction that is obtained by dividing the loss from the activity for the applicable tax year by the total sum of losses for the applicable tax year from all activities that had a loss for the year. You can use Form 8582 to calculate the ratable portion of the loss for each activity in which the passive activity is disallowed.
To illustrate the above, we can use example. Let’s assume that John has an interest in three passive activities. Two of the activities have losses, ($10,000) and ($15,000), while the other interest has a gain of $5,000. The $20,000 passive loss for the year is disallowed, and thus a portion of the losses from the two loss activities is disallowed. The disallowed portion of the losses would be calculated as follows: $20,000 x $10,000/$25,000 and $20,000 x $15,000/$25,000.
When all or a portion of a passive loss is disallowed, a ratable portion of each of the passive activity deductions, other than a deduction that would be excluded from the applicable activity is disallowed. Thus, it is important to define and understand what would constitute an excluded deduction. An excluded deduction would be defined as a passive activity deduction that is taken into account when computing your net income from an item of property for a taxable year where an amount of the taxpayer’s gross income from the property is treated as if it is not from a passive activity. When identifying disallowed deductions or excluded deductions, you do not always need to account for a separate deduction. Form 8582 can also be used if you have deductions for a passive activity that needs to be identified separately.
f you have passive losses and have tax questions related to these passive losses, you can speak with a tax attorney and business attorney at The McGuire Law Firm. You can schedule a free consultation with a tax attorney and business attorney in Denver, Colorado or Golden, Colorado.