Passive activities loss limitation may not allow you to deduct your loss from your other income

Passive activities loss limitation in US Tax
  • by admin
  • December 14, 2020

Do you know a loss from passive activities will have limitations for tax purposes? You may not be allowed by IRS to set it off against your other income on your tax return. Let’s discuss in detail to get an understanding of passive activities rules for tax purposes. 

Loss from your passive activities is treated differently on your income tax return in the United States. Rules for passive activity loss limitation apply to your tax return when you report passive activity loss on your tax return. Canada does not have this passive activity loss limitation rule under the Canadian taxation system.


Passive activity loss limitation rules


General rule – You cannot deduct your passive activity loss from other income. Other income means those which are not considered passive activity income. Suppose you have a rental loss to report on your tax return and you also have employment income to report in the same. You can not offset your rental loss with the employment income. Your passive activity loss is deferred and can only be offset when you have passive activity income. There is an expectation to the general rule when you rental loss from real property. This rule has been discussed below under “Rental Activities” and it’s called Special allowance.


Let’s look into what is considered “Passive Activities”

There are two kinds of passive activities.

  • Trade or business activities in which you do not participate materially during the year.
  • Rental activities, even if you do participate materially in them unless you are a real estate professional.


Rental activities

The rental activity is defined as and when you allow a customer to use your personal or real physical property to be used by the customer or keep that property to be available for the customer for use, in anticipation of an income paid, to be paid or expected for the use of this property. It does not matter whether you call the transaction a lease, rental, service contact, or some other arrangements.


Exceptions. Your activity is not a rental activity

if any of the following apply.

  1. The average period of customer stay is less than 8 days at the property, like hotels and Motels.
  2. The average period of customer stay at the property is less than 31 days, and you provide significant personal services with the rentals. Only services performed by individuals are included under significant personal services.

Personal services are considered significant if all relevant facts and situations are taken into consideration, which includes the frequency of the services, the type and the extent of labor required to perform the services, and the value of the services with respect to the amount charged for the use of the property. Significant personal services do not include the following.


  1. Services are needed to permit the lawful use of the property.
  2. Services to repair or improve the property that would extend its useful life for a period substantially longer than the average rental; and Services that are similar to those commonly provided with long-term rentals of real estates, such as cleaning and maintaining common areas or routine repairs.
  3. You provide special personal services in making the rental property available for customer use. Services are especially personal services if individuals perform them, and the customers’ use of the property is incidental to their receipt of the services.
  4. The rental is incidental to other than rental activity. You are holding the property for investment with the purpose to realize a gain from its appreciation and the incidental rental revenue realized is less than 2% of either the property’s unadjusted basis or fair market value, whichever is less.
  5. The rental of property is incidental to an activity of holding property for investment if the main purpose of holding the property is to realize a gain from its appreciation and the gross rental income from the property is less than 2% of the smaller of the property’s unadjusted basis or fair market value.
  6. You usually make the rental property available during stated business hours for nonexclusive use by various customers.
  7. You provide the property for use for other than rental activity in your capacity as an owner of an interest in the partnership, S corporation, or joint venture conducting that activity.


Special allowance rule – This is an exception to the general rule. If you qualify under this rule, you will be allowed to use your passive activity loss up to $25,000 and you can set off this loss against your other income. To qualify for this special allowance rule you have to establish that either you or your spouse actively participated in rental estate rental activity. The passive activity loss that you are reporting is from the same rental real estate activity.

A taxpayer is considered as actively participating in the real estate rental activity when the taxpayer has at least 10% ownership in that real estate property, he/she makes all the significant management decisions. The significant management decisions include approving a tenant, deciding the terms and conditions with the tenant, and approving all major expenses.

Under the general rule, you defer your entire passive activity loss. If you are eligible to claim the above special allowance, the deferral of your passive activity loss will reduce to the extent of your special allowance claim.


Phaseout rule – The amount you can claim under the above special allowance rule will also depend on your filing status and the adjusted gross income reported on your tax return.


Trade or Business Activities

A trade or business activity is an activity that:

  • Involves the conduct of a trade or business
  • Is conducted in anticipation of starting a trade or business, or
  • Research or experimental activities, where the expenditures that are deductible under Internal Revenue Code section 174 (or that would be deductible if you chose to deduct rather than capitalize them).

A trade or business activity does not include a rental activity or the rental of property that is incidental to an activity of holding the property for investment.

You generally report trade or business activities on Schedule C, F, or in Part II or III of Schedule E.


What is material participation in a trade or business:

  • You at least work 500 hours in a year for your business
  • Your involvement in the business in the business activities is continuous, year over year
  • If you have less than 100 hours in a year, it may not qualify as material participation
  • You materially participate in the business
  • Only providing management decisions will not be counted as material participation


The application of these rules is sometimes very complicated. You may need to consult a U.S. tax expert if you are stuck in any such situations. Their guidance can help you plan your losses better. Remember a tox loss is an asset.


Resources used: IRS Publication 925-2019


RKB Accounting has expertise in cross-border taxation and has been providing accounting and taxation services for the last fifteen years in Canada and USA. RKB services include incorporating a business on both sides of the border, bookkeeping, sales tax, payroll, and corporate and personal income tax. RKB’s expertise includes cross-border tax planning, long-term tax planning, helping business start-ups, business structure planning, and resolving complex tax matters. RKB a CPA(Delaware), CA(India), and CIA(USA) has over 25 years of experience in accounting and taxation in dealing with various countries in the world.

Disclaimer: Information in the blog/post/article has been presented for a broad and simple understanding. This is not legal advice. RKB Accounting & Tax Services does not accept any liability for its application in any real situations. You need to contact your accountant or us for further information.

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