Passive Activity Rules
The passive activity rules are designed to prevent you from passively investing in losing businesses and using those losses to offset income from your “real” business or businesses.
Passive Activity. There are two kinds of passive activity:1
Rental activities, even if you do materially participate in them, unless you are a real estate professional. (See below.)
Passive activity loss disallowed. In any in which you own a passive activity, you can use losses from that activity only as an offset against income from other passive activities. If you have a net loss from all passive activities, you have a passive activity loss, which you must carry forward to the following year or years until:2
You have enough passive activity income to absorb the loss; or
More than one-half of the personal services you perform in all your businesses are in real property trades or businesses in which you materially participate; and
Your perform more than 750 hours of personal services in those real property trades or businesses.
A Real Property Trade or Business is any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage business.5
1 IRC Section 469(c)(1), (c)(2), (c)(4).
2 IRC Section 469(a), (b), (d).
3 IRC Section 469(g)(1).
4 IRC Section 469(c)(7)(B).
5 IRC Section 469(c)(7)(C).