What is ‘Passive Activity’
Passive activity is activity in which the taxpayer did not materially participate in during the tax year. Internal Revenue Service (IRS) defines two types of passive activity: trade or business activities not materially participated in, and rental activities even if the taxpayer materially participated in them (unless the taxpayer is a real estate professional). Material participation is defined by the IRS as involvement in the activity of the business on a regular, continuous and substantial basis.
The passive activity rules apply to individuals, estates, trusts (except grantor trusts), closely held corporations, and personal service corporations.
Explaining ‘Passive Activity’
Income from rental properties is a suitable example of a passive activity. Making a distinction between passive and active income is important because the taxpayer can claim a passive loss only against income generated from passive activities. A passive loss cannot be claimed against active income. Any excess passive activity loss can be carried forward to future years until used, or until it can be deducted in the year when the taxpayer disposes of the passive activity in a taxable transaction.
Further Reading
- Passive activity: Millennials and financial advisory – ecommons.cornell.edu [PDF]
- At-risk and passive activity limitations: can complexity be reduced – heinonline.org [PDF]
- Whither mammon? Postmodern economics and passive enrichment – journals.sagepub.com [PDF]
- The Passive Activity Provisions–A Tax Policy Blooper – heinonline.org [PDF]
- The shift from active to passive investing: potential risks to financial stability? – papers.ssrn.com [PDF]
- Active and passive learning in agent-based financial markets – link.springer.com [PDF]
- A Whirlwind Tour of the Internal Revenue Code's At-Risk and Passive Activity Loss Rules – www.jstor.org [PDF]
- Timber Growers and the Passive Activity Loss Rules: Some Unintended Effects – heinonline.org [PDF]
- The Shift from Active to Passive Investing: Risks to Financial Stability? – www.tandfonline.com [PDF]
