Has anyone ever told you that your investment in a business or in real estate is a passive activity? Do you know what that means? Don't worry, most people don't.
Before 1986, investors would create tax shelters for themselves by putting their money into investments that would generate tax losses but no actual economic losses. For example, they may invest in a rental property and then would rent the property to a tenant for an amount equal to the monthly expenses. The investors would then have no net cash inflow or outflow, but would be able to depreciate the property and claim a tax loss.
Congress eventually caught on to the games that investors were playing with the Tax Code as it existed back then, and as a response invented the passive activity rules.
Under the passive activity rules, there are two types of passive activities. The first type of passive activity are trade or business activities in which you do not materially participate. In the next blog post we will discuss how this is determined. The second type of passive activity are rental activities (although there are two exceptions that will be discussed in future blog posts).
The income and gains on passive activities will continue to be taxed just like any other ordinary income and gains. However, the losses on passive activities are not deductible but instead can only be used to offset passive activity income. The passive activities losses are deferred until they can either offset passive activity income or the underlying investment is completely disposed of (e.g., sold).
In addition to not being able to deduct passive activity losses against your active income, the passive activity income is subject to the 3.8% Medicare Surtax.
Do you think you might have a "passive activity" investment? If you would like to discuss whether it truly is a passive activity and how that affects your taxes, please send me an e-mail.
Congress eventually caught on to the games that investors were playing with the Tax Code as it existed back then, and as a response invented the passive activity rules.
Under the passive activity rules, there are two types of passive activities. The first type of passive activity are trade or business activities in which you do not materially participate. In the next blog post we will discuss how this is determined. The second type of passive activity are rental activities (although there are two exceptions that will be discussed in future blog posts).
The income and gains on passive activities will continue to be taxed just like any other ordinary income and gains. However, the losses on passive activities are not deductible but instead can only be used to offset passive activity income. The passive activities losses are deferred until they can either offset passive activity income or the underlying investment is completely disposed of (e.g., sold).
In addition to not being able to deduct passive activity losses against your active income, the passive activity income is subject to the 3.8% Medicare Surtax.
Do you think you might have a "passive activity" investment? If you would like to discuss whether it truly is a passive activity and how that affects your taxes, please send me an e-mail.
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