There are two kinds of passive activities: trade or business activities in which the taxpayer does not materially participate during the year; and rental activities, even if the taxpayer does not materially participate in them, unless the taxpayer is a real estate professional. Many taxpayers have heard the term “passive activity” in relation to a rental activity and wondered exactly what it means.
An activity is a rental activity if real or personal tangible property is used or held for use by a taxpayer and gross income or expected gross income from the activity represents amounts paid or to be paid primarily for the property’s use, whether pursuant to a lease, service contract, or other agreement.
Of course there are exceptions to this rule. One is if the average period of customer use of the property is seven (7) days or less. Another exception is if the average period of customer use of the property is 30 days or less and the lessor provides significant personal services with the rental. Significant personal services may only include services performed by individuals. All relevant facts and circumstances are taken into consideration to determine if personal services are significant. The facts considered include the frequency of the services, the type and amount of labor required to perform the services, and the value of the services relative to the amount charged for use of the property.
An activity is also not a rental activity if the owner provides extraordinary personal services in making the rental property available for customer use. Services are extraordinary personal services if they are performed by individuals and the customers’ use of the property is incidental to their receipt of the services. A similar exception is when the rental is incidental to a nonrental actvity.
Rental property made available during defined business hours for nonexclusive use by different customers is also not a rental activity. Nor is it a rental activity if the property is provided for use in a nonrental capacity in the owner’s capacity as an owner of an interest in a S corporaation, partnership or joint venture. In all of the aforementioned situations an actvity is not a rental activity.
Rental property that has generated losses in past tax years may have suspended passive activity losses (PALs), which may only be deducted against passive income, i.e., that from other passive business activities and rentals. Suspended PALs may be deducted when the property is sold that generated them. If you sell a rental property with suspended PALs, you may be able to deduct them on top of deducting any § 1231 loss from the sale. Like § 1231 losses, deductible PALs can also create or increase an NOL that you can carry backward or forward.
Deductions or losses from passive activities are limited. You generally cannot offset income, other than passive income, with losses from passive activities. Nor can you offset taxes on income, other than passive income, with credits resulting from passive activities.
If you have questions about real estate loss deductions and passive activity limits, call THE TAX EXPERTS AT THE Thorgood Law Firm www.thorgoodlaw.com. For a FREE consultation, call 212-490-0704.
