Passive Activity Restrictions
Loss Restrictions: Passive Activities and At-Risk Limits
The passive activity laws were intended to discourage tax-shelter investments, but their reach goes beyond tax shelters to cover all real estate investors and persons who invest in businesses as "silent partners" or who are not involved full-time in the business. The passive activity rules prevent an investor from deducting what the law defines as a passive loss from:
- Salary
- Self-employment income
- Interest
- Dividends
- Sales of investment property
- Retirement income
Such losses are deductible only from income from other passive activities.
Fortunately, losses disallowed by the passive activity rules are suspended and carried forward to later taxable years and become deductible only when passive income is realized or substantially all of the activity is sold.
On your tax return, passive income items and allowable deductible items are reported as regular income and deductions. For example, rental income and allowable deductions are reported on Schedule E. However, before you make these entries, you may have to prepare Form 8582, which identifies your passive income and losses and helps you to determine whether passive loss items are deductible.
At-risk rules generally limit losses for an activity to your cash investment and loans for which you are personally liable, as well as certain non-recourse financing for real estate investments.
