Passive Activity Loss Rules

What is ‘Passive Activity Loss Rules’

A set of rules that prohibits using passive losses to offset earned or ordinary income. Passive activity loss rules prevent investors from using losses incurred from income-producing activities in which they are not materially involved.

Being materially involved with earned or ordinary income-producing activities means the income is active income and may not be reduced by passive losses. Passive losses can be used only to offset passive income.

Explaining ‘Passive Activity Loss Rules’

The key issue with passive activity loss rules is material participation. If the taxpayer does not materially participate in the activity that is producing the passive losses, then those losses can only be declared against passive income. If there is no passive income, then no loss can be deducted.

Passive activity losses can only be carried forward; they cannot be carried back.

Further Reading

  • Tax Policy and the Passive Loss Rules: Is Anybody Listening – [PDF]
  • A Whirlwind Tour of the Internal Revenue Code's At-Risk and Passive Activity Loss Rules – [PDF]
  • At-risk and passive activity limitations: can complexity be reduced – [PDF]
  • The Passive Activity Provisions–A Tax Policy Blooper – [PDF]
  • Timber Growers and the Passive Activity Loss Rules: Some Unintended Effects – [PDF]
  • Passive Activity Losses, Trusts, and Estates: The Regulations (If I Were King) – [PDF]
  • Material Participation Under the Passive Activity Loss Provisions – [PDF]
  • Effects of the Tax Reform Act of 1986 on corporate financial policy and organizational form – [PDF]
  • A Policy Critique of the Section 469 Passive Loss Rules – [PDF]