Passive Activities Discussed by Denver Tax Attorney

Many individuals do not understand passive activities & passive losses and the Internal Revenue Code Sections and Treasury Regulations that provide the tax law surrounding passive activities.  Further, you may not be aware that losses from passive activities may be disallowed or “suspended” so to speak.  John McGuire, is a tax attorney at The McGuire Law Firm and has prepared the article below to provide information regarding passive activities.

Passive activities would be considered business activities or other trade activities whereby you do not materially participate in the business.  Material participation involves regular, continuous and substantial involvement in the operation of the business or trade.  A common passive activity could be your involvement with rental properties and real estate.  Generally, rental properties and real estate activity is considered passive even if you are materially participating in the activity.  It is important to note that you may be considered a real estate professional and with such designation your rental activities may not be considered a passive activity. Below are some common questions and issues related to passive activities.

Who do the passive activity rules apply to?  The rules will apply to the following:

  • Individuals
  • Trusts (other than grantor trusts)
  • Estates
  • Closely held corporations
  • Personal Service Corporations

Although, the passive activity rules do not apply directly to a partnership, S corporation or grantor trust, it should be noted and understood how the passive activity rules can apply to the owners of these entities.

In general, a passive activity loss will be disallowed.  Your passive loss would be the excess of your passive deductions over the gross income from your passive activities.  Certain passive losses may be allowed, which are issues for a separate article.  So, if a passive loss is disallowed, what happens to the loss or do you ever get to use or take advantage of the loss.  In general, you may be able to take the disallowed loss or losses when you dispose of your entire and total interest in the property.  For example, assume you could not take certain losses from real estate due to your adjusted gross income or other issues.  When you do sell the property and dispose of your entire interest in that real estate whereby the loss has been disallowed, you may be able to claim the previously disallowed passive activity losses.  This is different from unused passive activity credits.  You cannot claim unused passive activity credits when you dispose of property with the unused credits.

You can contact The McGuire Law Firm to speak with a tax attorney regarding your individual and/or business tax matters.  In addition to his law degree, John McGuire holds an LL.M., which is an advanced degree in taxation. Mr. McGuire’s practice focuses primarily on tax issues before the IRS, individual & business income tax matters & law and business transactions.

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Contact The McGuire Law Firm at 720-833-7705 or to speak with a tax attorney in Denver, Colorado or Golden, Colorado.



Passive Activity Losses

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.

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