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collection through the Federal Register process; for more info, click here.Publication 925
Cat. No. 64265X Contents
Passive Activity
Future Developments . . . . . . . . . . . . 1
Department
of the Reminders . . . . . . . . . . . . . . . . . . . 1
and
Treasury
Introduction . . . . . . . . . . . . . . . . . . 2
DRAFT AS OF
Internal
Revenue
At-Risk Rules
Service Passive Activity Limits . . . . . ...... 2
Who Must Use These Rules? ...... 2
Passive Activities . . . . . . . ...... 3
Activities That Aren’t Passive
Activities . . . . . . . . . . ...... 5
Passive Activity Income and
November 1, 2021
For use in preparing Deductions . . . . . . . . ...... 6
Grouping Your Activities . . . ...... 8
2021 Returns Recharacterization of Passive
Income . . . . . . . . . .
Dispositions . . . . . . . . . .
. . . . . 10
. . . . . 11
How To Report Your Passive
Activity Loss . . . . . . . . . . . . 12
At-Risk Limits . . . . . . . . . . . . . . . . 12
Who Is Affected? . . . . . . . . . . . . 12
Activities Covered by the
At-Risk Rules . . . . . . . . . . . . 13
At-Risk Amounts . . . . . . . . . . . . 14
Amounts Not at Risk . . . . . . . . . . 14
Reductions of Amounts at Risk . . . . 15
Recapture Rule . . . . . . . . . . . . . 15
How To Get Tax Help . . . . . . . . . . . 15
Index . . . . . . . . . . . . . . . . . . . . . 17
Future Developments
For the latest developments related to Pub.
925, such as legislation enacted after it was
published, go to IRS.gov/Pub925.
Reminders
Regrouping due to Net Investment Income
Tax. You may be able to regroup your activities
if you’re subject to the Net Investment Income
Tax. See Regrouping Due to Net Investment In-
come Tax under Grouping Your Activities, later,
for more information.
At-risk amounts. The following rules apply to
amounts borrowed after May 3, 2004.
• You must file Form 6198, At-Risk Limita-
tions, if you’re engaged in an activity inclu-
ded in (6) under Activities Covered by the
At-Risk Rules and you have borrowed cer-
tain amounts described in Certain bor-
rowed amounts excluded under At-Risk
Amounts in this publication.
• You may be considered at risk for certain
amounts described in Certain borrowed
amounts excluded under At-Risk Amounts
secured by real property used in the activ-
ity of holding real property (other than min-
eral property) that, if nonrecourse, would
Get forms and other information faster and easier at:
• IRS.gov (English) • IRS.gov/Korean (한국어) be qualified nonrecourse financing.
• IRS.gov/Spanish (Español) • IRS.gov/Russian (Pусский) Photographs of missing children. The Inter-
• IRS.gov/Chinese (中文) • IRS.gov/Vietnamese (Tiếng Việt) nal Revenue Service is a proud partner with the
National Center for Missing & Exploited
Oct 28, 2021Children® (NCMEC). Photographs of missing 8582 Passive Activity Loss Limitations
8582 Allocation of disallowed passive activity
children selected by the Center may appear in loss among activities. If all or any part of your
this publication on pages that would otherwise 8582-CR Passive Activity Credit
8582-CR
passive activity loss is disallowed for the tax
be blank. You can help bring these children Limitations year, a ratable portion of the loss (if any) from
home by looking at the photographs and calling 8810 Corporate Passive Activity Loss and each of your passive activities is disallowed.
800-THE-LOST (800-843-5678) if you recog- The ratable portion of a loss from an activity is
8810
Credit Limitations
nize a child. computed by multiplying the passive activity
8949 Sales and Other Dispositions of loss that’s disallowed for the tax year by the
DRAFT AS OF
Introduction fraction obtained by dividing:
8949
Capital Assets
See How To Get Tax Help at the end of this 1. The loss from the activity for the tax year;
This publication discusses two sets of rules that by
may limit the amount of your deductible loss publication for information about getting these
from a trade, business, rental, or other in- publications and forms. 2. The sum of the losses for the tax year from
come-producing activity. The first part of the all activities having losses for the tax year.
publication discusses the passive activity rules.
Passive Activity Limits
November 1, 2021
Use Worksheet 5 of Form 8582 to figure the rat-
The second part discusses the at-risk rules.
able portion of the loss from each activity that’s
However, when you figure your allowable los-
disallowed.
ses from any activity, you must apply the at-risk
rules before the passive activity rules.
Who Must Use These Rules? Loss from an activity. The term “loss from
an activity” means:
Comments and suggestions. We welcome The passive activity rules apply to:
your comments about this publication and sug- • Individuals, 1. The amount by which the passive activity
gestions for future editions. • Estates, deductions (defined later) from the activity
You can send us comments through • Trusts (other than grantor trusts), for the tax year exceed the passive activity
IRS.gov/FormComments. Or, you can write to • Personal service corporations, and gross income (defined later) from the ac-
the Internal Revenue Service, Tax Forms and • Closely held corporations. tivity for the tax year; reduced by
Publications, 1111 Constitution Ave. NW, Even though the rules don’t apply to grantor 2. Any part of such amount that’s allowed un-
IR-6526, Washington, DC 20224. trusts, partnerships, and S corporations directly, der the Special $25,000 allowance, later.
Although we can’t respond individually to they do apply to the owners of these entities. If your passive activity gross income from
each comment received, we do appreciate your
significant participation passive activities (de-
feedback and will consider your comments and For information about personal service cor-
fined later) for the tax year is more than your
suggestions as we revise our tax forms, instruc- porations and closely held corporations, includ-
passive activity deductions from those activities
tions, and publications. Don’t send tax ques- ing definitions and how the passive activity
for the tax year, those activities shall be treated,
tions, tax returns, or payments to the above ad- rules apply to these corporations, see Form
solely for purposes of figuring your loss from the
dress. 8810 and its instructions.
activity, as a single activity that doesn’t have a
Getting answers to your tax questions. Before applying the passive activity loss for such taxable year. See Significant Par-
If you have a tax question not answered by this ! limits, you must first determine the ticipation Passive Activities, later.
publication or the How To Get Tax Help section CAUTION amount of the deductions disallowed
at the end of this publication, go to the IRS In- under the basis, excess farm loss, or at-risk Example. John Pine holds interests in three
teractive Tax Assistant page at IRS.gov/ rules. See Passive Activity Deductions, later. passive activities, A, B, and C. The gross in-
Help/ITA where you can find topics using the come and deductions from these activities for
search feature or by viewing the categories lis- the taxable year are as follows.
ted. Passive Activity Loss
Getting tax forms, instructions, and pub- A B C Total
Generally, the passive activity loss for the tax
lications. Visit IRS.gov/Forms to download year isn’t allowed. However, there is a special
current and prior-year forms, instructions, and Gross
allowance under which some or all of your pas- income $7,000 $4,000 $12,000 $23,000
publications. sive activity loss may be allowed. See Special
Ordering tax forms, instructions, and $25,000 allowance, later. Deductions (16,000) (20,000) (8,000) (44,000)
publications. Go to IRS.gov/OrderForms to
order current forms, instructions, and publica- Definition of passive activity loss. Gener-
tions; call 800-829-3676 to order prior-year ally, your passive activity loss for the tax year is Net
forms and instructions. The IRS will process the excess of your passive activity deductions income
over your passive activity gross income. See (loss) ($9,000) ($16,000) $4,000 ($21,000)
your order for forms and publications as soon
as possible. Don’t resubmit requests you’ve al- Passive Activity Income and Deductions, later.
For a closely held corporation, the passive John Pine’s $21,000 passive activity loss for
ready sent us. You can get forms and publica-
activity loss is the excess of passive activity de- the taxable year is disallowed. Therefore, a rat-
tions faster online.
ductions over the sum of passive activity gross able portion of the losses from activities A and
income and net active income. For details on B is disallowed. He figures the disallowed por-
Useful Items net active income, see the Instructions for Form tion of each loss as follows.
You may want to see:
8810. For the definition of passive activity gross
income, see Passive Activity Income, later. For A: $21,000 x $9,000/$25,000 $7,560
Publication the definition of passive activity deductions, see B: $21,000 x $16,000/$25,000 13,440
527 Residential Rental Property Passive Activity Deductions, later.
Total $21,000
527
(Including Rental of Vacation Homes)
Identification of Disallowed
541 Partnerships Passive Activity Deductions Allocation within loss activities. If all or any
541
Form (and Instructions) part of your loss from an activity is disallowed
If all or a part of your passive activity loss is dis- under Allocation of disallowed passive activity
4952 Investment Interest Expense allowed for the tax year, you may need to allo- loss among activities for the tax year, a ratable
cate the disallowed passive activity loss among
4952
Deduction portion of each of your passive activity deduc-
different passive activities and among different tions (defined later), other than an excluded
6198 At-Risk Limitations
6198 deductions within a passive activity.
Page 2 Publication 925 (2021)deduction (defined below) from such activity is tax year. Credits that are included in figuring the Trade or Business Activities
disallowed. The ratable portion of a passive ac- general business credit are subject to the pas-
tivity deduction is the amount of the disallowed sive activity rules. A trade or business activity is an activity that:
portion of the loss from the activity for the tax • Involves the conduct of a trade or business
year multiplied by the fraction obtained by divid- See the Instructions for Form 8582-CR for (that is, deductions would be allowable un-
ing: more information. der section 162 of the Internal Revenue
Code if other limitations, such as the pas-
1. The amount of such deduction; by
Publicly Traded Partnership sive activity rules, didn’t apply);
DRAFT AS OF
2. The sum of all of your passive activity de- • Is conducted in anticipation of starting a
ductions (other than excluded deductions) trade or business; or
from that activity from the tax year. You must apply the rules in this part separately • Involves research or experimental expen-
to your income or loss from a passive activity ditures that are deductible under Internal
Excluded deductions. “Excluded deduc- held through a publicly traded partnership Revenue Code section 174 (or that would
tion” means any passive activity deduction (PTP). You must also apply the limit on passive be deductible if you chose to deduct rather
that’s taken into account in computing your net activity credits separately to your credits from a than capitalize them).
income from an item of property for a taxable
November 1, 2021
passive activity held through a PTP.
year in which an amount of the taxpayer's gross A trade or business activity doesn’t include a
income from such item of property is treated as You can offset deductions from passive ac- rental activity or the rental of property that’s inci-
not from a passive activity. See Recharacteriza- tivities of a PTP only against income or gain dental to an activity of holding the property for
tion of Passive Income, later. from passive activities of the same PTP. Like- investment.
wise, you can offset credits from passive activi-
Separately identified deductions. In ties of a PTP only against the tax on the net You generally report trade or business activ-
identifying the deductions from an activity that passive income from the same PTP. This sepa- ities on Schedule C, F, or in Part II or III of
are disallowed, you don’t need to account sepa- rate treatment rule also applies to a regulated Schedule E.
rately for a deduction unless such deduction investment company holding an interest in a
may, if separately taken into account, result in
an income tax liability for any tax year different
PTP for the items attributable to that interest. Rental Activities
from that which would result were such deduc- For more information on how to apply the A rental activity is a passive activity even if you
tion not taken into account separately. passive activity loss rules to PTPs, and on how materially participated in that activity, unless
Use Form 8582, Worksheet 7, for any activ- to apply the limit on passive activity credits to you materially participated as a real estate pro-
ity if you have passive activity deductions for PTPs, see Publicly Traded Partnerships (PTPs) fessional. See Real Estate Professional under
that activity that must be separately identified. in the instructions for Forms 8582 and Activities That Aren’t Passive Activities, later.
Deductions that must be accounted for sep- 8582-CR, respectively. An activity is a rental activity if tangible property
arately include (but aren’t limited to) the follow-
(real or personal) is used by customers or held
ing deductions.
• Deductions that arise in a rental real estate Excess Farm Loss for use by customers, and the gross income (or
expected gross income) from the activity repre-
activity in tax years in which you actively
sents amounts paid (or to be paid) mainly for
participate in such activity. See Active par- If you have an excess farm loss for the tax year,
the use of the property. It doesn’t matter
ticipation, later. special rules may apply. These rules don’t ap-
whether the use is under a lease, a service con-
• Deductions that arise in a rental real estate ply to C corporations. For information on excess
tract, or some other arrangement.
activity in tax years in which you don’t ac- farm losses, see the Instructions for Schedule F
tively participate in such activity. See Ac- (Form 1040), Profit or Loss From Farming. Exceptions. Your activity isn’t a rental activity
tive participation, later. if any of the following apply.
• Losses from sales or exchanges of capital Passive Activities
assets. 1. The average period of customer use of the
• Section 1231 losses. See Section 1231 property is 7 days or less. You figure the
Gains and Losses in Pub. 544, Sales and There are two kinds of passive activities. average period of customer use by divid-
Other Dispositions of Assets, for more in- • Trade or business activities in which you ing the total number of days in all rental
formation. don’t materially participate during the year. periods by the number of rentals during
• Rental activities, even if you do materially the tax year. If the activity involves renting
participate in them, unless you’re a real es- more than one class of property, multiply
Carryover of Disallowed tate professional. the average period of customer use of
Deductions each class by a fraction. The numerator of
Material participation in a trade or business is
discussed, later, under Activities That Aren’t the fraction is the gross rental income from
In the case of an activity with respect to which
Passive Activities. that class of property and the denominator
any deductions or credits are disallowed for a
is the activity's total gross rental income.
taxable year (the loss activity), the disallowed
Treatment of former passive activities. A The activity's average period of customer
deductions are allocated among your activities
former passive activity is an activity that was a use will equal the sum of the amounts for
for the next tax year in a manner that reasona-
passive activity in any earlier tax year, but isn’t a each class.
bly reflects the extent to which each activity
continues the loss activity. The disallowed de- passive activity in the current tax year. You can 2. The average period of customer use of the
ductions or credits allocated to an activity under deduct a prior-year unallowed loss from the ac- property, as figured in (1) above, is 30
the preceding sentence are treated as deduc- tivity up to the amount of your current-year net days or less and you provide significant
tions or credits from the activity for the next tax income from the activity. Treat any remaining personal services with the rentals. Signifi-
year. For more information, see Regulations prior-year unallowed loss like you treat any cant personal services include only serv-
section 1.469-1(f)(4). other passive loss. ices performed by individuals. To deter-
In addition, any prior-year unallowed pas- mine if personal services are significant,
sive activity credits from a former passive activ-
Passive Activity Credit ity offset the allocable part of your current-year
all relevant facts and circumstances are
taken into consideration, including the fre-
tax liability. The allocable part of your cur- quency of the services, the type and
Generally, the passive activity credit for the tax
rent-year tax liability is that part of this year's tax amount of labor required to perform the
year is disallowed.
liability that‘s allocable to the current-year net services, and the value of the services rel-
The passive activity credit is the amount by income from the former passive activity. You ative to the amount charged for use of the
which the sum of all your credits subject to the figure this after you reduce your net income property. Significant personal services
passive activity rules exceed your regular tax from the activity by any prior-year unallowed don’t include the following.
liability allocable to all passive activities for the loss from that activity (but not below zero).
Publication 925 (2021) Page 3a. Services needed to permit the lawful general rule disallowing the passive activity investment credit from rental real estate activi-
use of the property; loss. Similarly, you can offset credits from the ties.
activity against the tax on up to $25,000 of non-
b. Services to repair or improve property
passive income after taking into account any Example. Mike, a single taxpayer, had the
that would extend its useful life for a
losses allowed under this exception. following income and loss during the tax year.
period substantially longer than the
average rental; and If you’re married, filing a separate return,
and lived apart from your spouse for the entire Salary . . . . . . . . . . . . . . . . . . . . . . . . . $42,300
c. Services that are similar to those tax year, your special allowance can’t be more Dividends . . . . . . . . . . . . . . . . . . . . . . . 300
DRAFT AS OF
commonly provided with long-term than $12,500. If you lived with your spouse at Interest . . . . . . . . . . . . . . . . . . . . . . . . . 1,400
rentals of real estate, such as clean- any time during the year and are filing a sepa- Rental loss . . . . . . . . . . . . . . . . . . . . . . (4,000)
ing and maintenance of common rate return, you can’t use the special allowance
areas or routine repairs. The rental loss came from a house Mike
to reduce your nonpassive income or tax on
owned. He advertised and rented the house to
3. You provide extraordinary personal serv- nonpassive income.
the current tenant himself. He also collected the
ices in making the rental property available The maximum special allowance is reduced
rents and did the repairs or hired someone to
for customer use. Services are extraordi- if your modified adjusted gross income exceeds
November 1, 2021
do them.
nary personal services if they’re performed certain amounts. See Phaseout rule, later.
Even though the rental loss is a loss from a
by individuals and the customers' use of passive activity, Mike can use the entire $4,000
the property is incidental to their receipt of Example. Kate, a single taxpayer, has
loss to offset his other income because he ac-
the services. $70,000 in wages, $15,000 income from a limi-
tively participated.
ted partnership, a $26,000 loss from rental real
4. The rental is incidental to a nonrental ac- estate activities in which she actively participa- Phaseout rule. The maximum special al-
tivity. The rental of property is incidental to ted, and isn’t subject to the modified adjusted lowance of $25,000 ($12,500 for married indi-
an activity of holding property for invest- gross income phaseout rule. She can use viduals filing separate returns and living apart at
ment if the main purpose of holding the $15,000 of her $26,000 loss to offset her all times during the year) is reduced by 50% of
property is to realize a gain from its appre- $15,000 passive income from the partnership. the amount of your modified adjusted gross in-
ciation and the gross rental income from She actively participated in her rental real es- come that’s more than $100,000 ($50,000 if
the property is less than 2% of the smaller tate activities, so she can use the remaining you’re married filing separately). If your modi-
of the property's unadjusted basis or fair $11,000 rental real estate loss to offset $11,000 fied adjusted gross income is $150,000 or more
market value. The unadjusted basis of of her nonpassive income (wages). ($75,000 or more if you’re married filing sepa-
property is its cost not reduced by depreci- rately), you generally can’t use the special al-
ation or any other basis adjustment. The Active participation. Active participation
lowance. This is because the special allowance
rental of property is incidental to a trade or isn’t the same as material participation (defined
is reduced to $0 since the modified adjusted
business activity if all of the following ap- later). Active participation is a less stringent
gross income is over the $100,000 amount.
ply. standard than material participation. For exam-
Modified adjusted gross income for this pur-
ple, you may be treated as actively participating
a. You own an interest in the trade or pose is your adjusted gross income figured
if you make management decisions in a signifi-
business activity during the year. without the following.
cant and bona fide sense. Management deci-
sions that count as active participation include
• Taxable social security and Tier 1 railroad
b. The rental property was used mainly retirement benefits.
in that trade or business activity dur- approving new tenants, deciding on rental
terms, approving expenditures, and similar de-
• Deductible contributions to individual re-
ing the current year, or during at least tirement accounts (IRAs) and section
2 of the 5 preceding tax years. cisions.
501(c)(18) pension plans.
Only individuals can actively participate in
c. Your gross rental income from the rental real estate activities. However, a dece-
• The exclusion from income of interest from
property is less than 2% of the smaller qualified U.S. savings bonds used to pay
dent's estate is treated as actively participating
of its unadjusted basis or fair market qualified higher education expenses.
for its tax years ending less than 2 years after
value. Lodging provided to an em- the decedent's death, if the decedent would
• The exclusion from income of amounts re-
ployee or the employee's spouse or ceived from an employer's adoption assis-
have satisfied the active participation require-
dependents is incidental to the activity tance program.
ment for the activity for the tax year the dece-
or activities in which the employee dent died.
• Passive activity income or loss included on
performs services if the lodging is fur- Form 8582.
A decedent's qualified revocable trust can
nished for the employer's conven- also be treated as actively participating if both
• Any rental real estate loss allowed be-
ience. cause you materially participated in the
the trustee and the executor (if any) of the es-
rental activity as a Real Estate Professio-
5. You customarily make the rental property tate choose to treat the trust as part of the es-
nal (as discussed, later, under Activities
available during defined business hours tate. The choice applies to tax years ending af-
That Aren’t Passive Activities).
for nonexclusive use by various custom- ter the decedent's death and before:
• 2 years after the decedent's death if no es- • Any overall loss from a publicly traded
ers. partnership (see Publicly Traded Partner-
tate tax return is required, or
6. You provide the property for use in a non- ships (PTPs) in the instructions for Form
• 6 months after the estate tax liability is fi- 8582).
rental activity in your capacity as an owner nally determined if an estate tax return is
of an interest in the partnership, S corpo- required.
• The deduction allowed for the deductible
ration, or joint venture conducting that ac- part of self-employment tax.
tivity. The choice is irrevocable and can’t be made • Foreign-derived intangible income and
later than the due date for the estate's first in- global intangible low-taxed income.
If you meet any of the exceptions listed come tax return (including any extensions). • The deduction allowed for interest on stu-
TIP above, see the Instructions for Form Limited partners aren’t treated as actively dent loans.
8582 for information about how to re- participating in a partnership's rental real estate
port any income or loss from the activity. activities. Example. During 2021, John was unmar-
You aren’t treated as actively participating in ried and wasn’t a real estate professional. For
Special $25,000 allowance. If you or your a rental real estate activity unless your interest 2021, he had $120,000 in salary and a $31,000
spouse actively participated in a passive rental in the activity (including your spouse's interest) loss from his rental real estate activities in which
real estate activity, the amount of the passive was at least 10% (by value) of all interests in the he actively participated. His modified adjusted
activity loss that’s disallowed is decreased and activity throughout the year. gross income is $120,000. When he files his
you therefore can deduct up to $25,000 of loss Active participation isn’t required to take the 2021 return, he can deduct only $15,000 of his
from the activity from your nonpassive income. low-income housing credit or the rehabilitation passive activity loss. He must carry over the re-
This special allowance is an exception to the maining $16,000 passive activity loss to 2022.
Page 4 Publication 925 (2021)He figures his deduction and carryover as fol- from the working interest may be treated any other trade or business in which capi-
lows. as passive activity gross income and pas- tal isn’t a material income-producing fac-
sive activity deductions. See Temporary tor.
Adjusted gross income, modified as Regulations section 1.469-1T(e)(4)(ii).
7. Based on all the facts and circumstances,
required . . . . . . . . . . . . . . . . . . . . . . . . $120,000
3. The rental of a dwelling unit that you also you participated in the activity on a regu-
Minus amount not subject to phaseout . . . . –100,000
used for personal purposes during the lar, continuous, and substantial basis dur-
year for more than the greater of 14 days ing the year.
or 10% of the number of days during the
DRAFT AS OF
Amount subject to phaseout rule . . . . . . . . $20,000 You didn’t materially participate in the activ-
Multiply by 50% . . . . . . . . . . . . . . . . . . . × 50% year that the home was rented at a fair
rental. ity under test (7) if you participated in the activ-
ity for 100 hours or less during the year. Your
Required reduction to special 4. An activity of trading personal property for participation in managing the activity doesn’t
allowance . . . . . . . . . . . . . $10,000
. . . . . . . . . . . the account of those who own interests in count in determining whether you materially
the activity. See Temporary Regulations participated under this test if:
Maximum special allowance . . . . . . . . . . . $25,000
section 1.469-1T(e)(6). • Any person other than you received com-
November 1, 2021
Minus required reduction (see above) . . . . –10,000 5. Rental real estate activities in which you pensation for managing the activity, or
materially participated as a real estate pro- • Any individual spent more hours during the
Adjusted special allowance . . . . . . . . . . . . $15,000 fessional. See Real Estate Professional, tax year managing the activity than you did
later. (regardless of whether the individual was
Passive loss from rental real estate . . . . . . $31,000 compensated for the management serv-
You shouldn’t enter income and losses ices).
Deduction allowable/Adjusted ! from these activities on Form 8582. In-
special allowance (see above) . . . . . . . . . –15,000 CAUTION stead, enter them on the forms or Participation. In general, any work you do in
schedules you would normally use. connection with an activity in which you own an
Amount that must be carried forward . . . . . $16,000 interest is treated as participation in the activity.
Exceptions to the phaseout rules. A Material Participation Work not usually performed by owners.
higher phaseout range applies to rehabilitation You don’t treat the work you do in connection
investment credits from rental real estate activi- A trade or business activity isn’t a passive activ- with an activity as participation in the activity if
ties. For those credits, the phaseout of the ity if you materially participated in the activity. both of the following are true.
$25,000 special allowance starts when your • The work isn’t work that’s customarily done
Material participation tests. You materially by the owner of that type of activity.
modified adjusted gross income exceeds
$200,000 ($100,000 if you’re a married individ-
participated in a trade or business activity for a • One of your main reasons for doing the
tax year if you satisfy any of the following tests. work is to avoid the disallowance of any
ual filing a separate return and living apart at all
times during the year). 1. You participated in the activity for more loss or credit from the activity under the
There is no phaseout of the $25,000 special than 500 hours. passive activity rules.
allowance for low-income housing credits. Participation as an investor. You don’t
2. Your participation was substantially all the
Ordering rules. If you have more than one participation in the activity of all individuals treat the work you do in your capacity as an in-
of the exceptions to the phaseout rules in the for the tax year, including the participation vestor in an activity as participation unless
same tax year, you must apply the $25,000 of individuals who didn’t own any interest you’re directly involved in the day-to-day man-
phaseout against your passive activity losses in the activity. agement or operations of the activity. Work you
and credits in the following order. do as an investor includes:
3. You participated in the activity for more • Studying and reviewing financial state-
1. Passive activity losses. than 100 hours during the tax year, and ments or reports on operations of the activ-
you participated at least as much as any ity,
2. The portion of passive activity credits at- other individual (including individuals who
tributable to credits other than the rehabili- • Preparing or compiling summaries or anal-
didn’t own any interest in the activity) for yses of the finances or operations of the
tation and low-income housing credits. the year. activity for your own use, and
3. The portion of passive activity credits at- 4. The activity is a significant participation • Monitoring the finances or operations of
tributable to the rehabilitation credit. activity, and you participated in all signifi- the activity in a nonmanagerial capacity.
4. The portion of passive activity credits at- cant participation activities for more than
tributable to the low-income housing 500 hours. A significant participation activ- Spouse's participation. Your participation in
credit. ity is any trade or business activity in an activity includes your spouse's participation.
which you participated for more than 100 This applies even if your spouse didn’t own any
hours during the year and in which you interest in the activity and you and your spouse
Activities That Aren’t didn’t materially participate under any of don’t file a joint return for the year.
Passive Activities the material participation tests, other than Proof of participation. You can use
this test. See Significant Participation Pas- any reasonable method to prove your
The following aren’t passive activities. sive Activities under Recharacterization of RECORDS participation in an activity for the year.
Passive Income, later. You don’t have to keep contemporaneous daily
1. Trade or business activities in which you
materially participated for the tax year. 5. You materially participated in the activity time reports, logs, or similar documents if you
(other than by meeting this fifth test) for can establish your participation in some other
2. A working interest in an oil or gas well that way. For example, you can show the services
any 5 (whether or not consecutive) of the
you hold directly or through an entity that you performed and the approximate number of
10 immediately preceding tax years.
doesn’t limit your liability (such as a gen- hours spent by using an appointment book, cal-
eral partner interest in a partnership). It 6. The activity is a personal service activity in endar, or narrative summary.
doesn’t matter whether you materially par- which you materially participated for any 3
ticipated in the activity for the tax year. (whether or not consecutive) preceding
However, if your liability was limited for tax years. An activity is a personal service Limited partners. If you owned an activity as a
part of the year (for example, you conver- activity if it involves the performance of limited partner, you generally aren’t treated as
ted your general partner interest to a limi- personal services in the fields of health (in- materially participating in the activity. However,
ted partner interest during the year) and cluding veterinary services), law, engi- you’re treated as materially participating in the
you had a net loss from the well for the neering, architecture, accounting, actuarial
year, some of your income and deductions science, performing arts, consulting, or
Publication 925 (2021) Page 5activity if you met test (1), (5), or (6) under Ma- Don’t count personal services you per- Passive activity income doesn’t include the
terial participation tests, discussed earlier, for formed as an employee in real property trades following items.
the tax year. or businesses unless you were a 5% owner of • Income from an activity that isn’t a passive
You aren’t treated as a limited partner, how- your employer. You were a 5% owner if you activity. These activities are discussed un-
ever, if you were also a general partner in the owned (or are considered to have owned) more der Activities That Aren’t Passive Activi-
partnership at all times during the partnership's than 5% of your employer's outstanding stock, ties, earlier.
tax year ending with or within your tax year (or, outstanding voting stock, or capital or profits in- • Portfolio income. This includes interest,
if shorter, during that part of the partnership's terest. dividends, annuities, and royalties not de-
DRAFT AS OF
tax year in which you directly or indirectly If you file a joint return, don’t count your rived in the ordinary course of a trade or
owned your limited partner interest). spouse's personal services to determine business. It includes gain or loss from the
whether you met the preceding requirements. disposition of property that produces these
Retired or disabled farmer and surviving However, you can count your spouse's partici- types of income or that’s held for invest-
spouse of a farmer. If you’re a retired or disa- pation in an activity in determining if you materi- ment. The exclusion for portfolio income
bled farmer, you’re treated as materially partici- ally participated. doesn’t apply to self-charged interest trea-
pating in a farming activity if you materially par- ted as passive activity income. For more
November 1, 2021
ticipated for 5 or more of the 8 years before Real property trades or businesses. A information on self-charged interest, see
your retirement or disability. Similarly, if you’re a real property trade or business is a trade or Self-charged interest, earlier.
surviving spouse of a farmer, you’re treated as business that does any of the following with real • Personal service income. This includes
materially participating in a farming activity if the property. salaries, wages, commissions, self-em-
real property used in the activity meets the es- • Develops or redevelops it. ployment income from trade or business
tate tax rules for special valuation of farm prop- • Constructs or reconstructs it. activities in which you materially participa-
erty passed from a qualifying decedent, and • Acquires it. ted, deferred compensation, taxable social
you actively manage the farm. • Converts it. security and other retirement benefits, and
• Rents or leases it. payments from partnerships to partners for
Corporations. A closely held corporation or a • Operates or manages it. personal services.
personal service corporation is treated as mate- • Brokers it. • Income from positive section 481 adjust-
rially participating in an activity only if one or Closely held corporations. A closely held ments allocated to activities other than
more shareholders holding more than 50% by corporation can qualify as a real estate profes- passive activities. (Section 481 adjust-
value of the outstanding stock of the corpora- sional if more than 50% of the gross receipts for ments are adjustments that must be made
tion materially participate in the activity. its tax year came from real property trades or due to changes in your accounting
A closely held corporation can also satisfy businesses in which it materially participated. method.)
the material participation standard by meeting • Income or gain from investments of work-
the first two requirements for the qualifying busi- ing capital.
ness exception from the at-risk limits. See Spe- Passive Activity Income • Income from an oil or gas property if you
cial exception for qualified corporations under and Deductions treated any loss from a working interest in
Activities Covered by the At-Risk Rules, later. the property for any tax year beginning af-
In figuring your net income or loss from a pas- ter 1986 as a nonpassive loss, as dis-
sive activity, take into account only passive ac- cussed in item (2) under Activities That
Real Estate Professional
tivity income and passive activity deductions. Aren’t Passive Activities, earlier. This also
Generally, rental activities are passive activities applies to income from other oil and gas
even if you materially participated in them. Self-charged interest. Certain self-charged property, the basis of which is determined
However, if you qualified as a real estate pro- interest income or deductions may be treated wholly or partly by the basis of the property
fessional, rental real estate activities in which as passive activity gross income or passive ac- in the preceding sentence.
you materially participated aren’t passive activi- tivity deductions if the loan proceeds are used • Any income from intangible property, such
ties. For this purpose, each interest you have in in a passive activity. as a patent, copyright, or literary, musical,
a rental real estate activity is a separate activity, Generally, self-charged interest income and or artistic composition, if your personal ef-
unless you choose to treat all interests in rental deductions result from loans between you and a forts significantly contributed to the crea-
real estate activities as one activity. See the In- partnership or S corporation in which you had a tion of the property.
structions for Schedule E (Form 1040), Supple- direct or indirect ownership interest. This in- • Any other income that must be treated as
mental Income and Loss, for information about cludes both loans you made to the partnership nonpassive income. See Recharacteriza-
making this choice. or S corporation and loans the partnership or S tion of Passive Income, later.
corporation made to you. • Overall gain from any interest in a publicly
It also includes loans from one partnership traded partnership. See Publicly Traded
If you qualified as a real estate professional
or S corporation to another partnership or S cor- Partnerships (PTPs) in the instructions for
for 2021, report income or losses from rental
poration if each owner in the borrowing entity Form 8582.
real estate activities in which you materially par-
ticipated as nonpassive income or losses, and has the same proportional ownership interest in • State, local, and foreign income tax re-
the lending entity. funds.
complete line 43 of Schedule E (Form 1040). If
you also have an unallowed loss from these ac- Exception. The self-charged interest rules • Income from a covenant not to compete.
tivities from an earlier year when you didn’t don’t apply to your interest in a partnership or S • Reimbursement of a casualty or theft loss
corporation if the entity made an election under included in gross income to recover all or
qualify, see Treatment of former passive activi-
Regulations section 1.469-7(g) to avoid the ap- part of a prior-year loss deduction, if the
ties under Passive Activities, earlier.
plication of these rules. For more details on the loss deduction wasn’t a passive activity de-
self-charged interest rules, see Regulations duction.
Qualifications. You qualified as a real estate
professional for the year if you met both of the section 1.469-7. • Alaska Permanent Fund dividends.
following requirements. • Cancellation of debt income, if at the time
the debt is discharged the debt isn’t alloca-
• More than half of the personal services you Passive Activity Income ted to passive activities under the interest
performed in all trades or businesses dur-
expense allocation rules. See chapter 4 of
ing the tax year were performed in real Passive activity income includes all income Pub. 535, Business Expenses, for informa-
property trades or businesses in which you from passive activities and generally includes tion about the rules for allocating interest.
materially participated. gain from disposition of an interest in a passive
• You performed more than 750 hours of activity or property used in a passive activity. Disposition of property interests. Gain on
services during the tax year in real property
the disposition of an interest in property is gen-
trades or businesses in which you materi-
erally passive activity income if, at the time of
ally participated.
Page 6 Publication 925 (2021)the disposition, the property was used in an ac- erty or similar property mainly for sale to tivity rules. See Coordination with other
tivity that was a passive activity in the year of customers in the ordinary course of a trade limitations on deductions that apply before
disposition. The gain generally isn’t passive ac- or business). the passive activity rules, later.
tivity income if, at the time of disposition, the • Your other activities included a nondealing • Deductions and losses that would have
property was used in an activity that wasn’t a activity (an activity that doesn’t involve been allowed for tax years beginning be-
passive activity in the year of disposition. An ex- holding similar property for sale to custom- fore 1987 but for basis or at-risk limits.
ception to this general rule may apply if you pre- ers in the ordinary course of a trade or • Net negative section 481 adjustments allo-
viously used the property in a different activity. business) in which you used the property cated to activities other than passive activi-
DRAFT AS OF
for more than 80% of the period you held it. ties. (Section 481 adjustments are adjust-
Exception for more than one use in the • You didn’t acquire or hold your interest in ments required due to changes in
preceding 12 months. If you used the prop- the property for the main purpose of selling accounting methods.)
erty in more than one activity during the it to customers in the ordinary course of a • Casualty and theft losses, unless losses
12-month period before its disposition, you trade or business. similar in cause and severity recur regu-
must allocate the gain between the activities on larly in the activity.
a basis that reasonably reflects the property's • The deduction allowed for the deductible
Passive Activity Deductions
November 1, 2021
use during that period. Any gain allocated to a part of self-employment tax.
passive activity is passive activity income.
For this purpose, an allocation of the gain Generally, a deduction is a passive activity de-
duction for a taxable year if and only if such de- Coordination with other limitations on de-
solely to the activity in which the property was ductions that apply before the passive ac-
mainly used during that period reasonably re- duction either:
tivity rules. An item of deduction from a pas-
flects the property's use if the fair market value 1. Arises in connection with the conduct of sive activity that’s disallowed for a tax year
of your interest in the property isn’t more than an activity that’s a passive activity for the under the basis or at-risk limitations isn’t a pas-
the lesser of: tax year, or sive activity deduction for the tax year. The fol-
• $10,000, or lowing sections provide rules for figuring the ex-
• 10% of the total of the fair market value of 2. Is treated as a deduction from an activity
for the tax year because it was disallowed tent to which items of deduction from a passive
your interest in the property and the fair activity are disallowed for a tax year under the
market value of all other property used in by the passive activity rules in the preced-
ing year and carried forward to the tax basis or at-risk limitations.
that activity immediately before the dispo-
sition. year. Proration of deductions disallowed un-
der basis limitations. If any amount of your
Exception for substantially appreciated For purposes of item (1) above, an item of distributive share of a partnership's loss for the
property. The gain is passive activity income if deduction arises in the taxable year in which the tax year is disallowed under the basis limitation,
the fair market value of the property at disposi- item would be allowable as a deduction under a ratable portion of your distributive share of
tion was more than 120% of its adjusted basis the taxpayer's method of accounting if taxable each item of deduction or loss of the partner-
and either of the following conditions applies. income for all taxable years were determined ship is disallowed for the tax year. For this pur-
• You used the property in a passive activity without regard to the passive activity rules and pose, the ratable portion of an item of deduction
for 20% of the time you held your interest without regard to the basis, excess farm loss, or loss is the amount of such item multiplied by
in the property. and at-risk limits. See Coordination with other the fraction obtained by dividing:
• You used the property in a passive activity limitations on deductions that apply before the
for the entire 24-month period before its passive activity rules, later. 1. The amount of your distributive share of
disposition. partnership loss that’s disallowed for the
Passive activity deductions generally in- taxable year, by
If neither condition applies, the gain isn’t pas-
sive activity income. However, it’s treated as clude any loss from a disposition of property 2. The sum of your distributive shares of all
portfolio income only if you held the property for used in a passive activity at the time of the dis- items of deduction and loss of the partner-
investment for more than half of the time you position and any loss from a disposition of less ship for the tax year.
held it in nonpassive activities. than your entire interest in a passive activity.
If any amount of your pro rata share of an S
For this purpose, treat property you held
Exceptions. Passive activity deductions don’t corporation's loss for the tax year is disallowed
through a corporation (other than an S corpora-
include the following items. under the basis limitation, a ratable portion of
tion) or other entity whose owners receive only
• Deductions for expenses (other than inter- your pro rata share of each item of deduction or
portfolio income as property held in a nonpas-
est expense) that are clearly and directly loss of the S corporation is disallowed for the
sive activity and as property held for invest-
allocable to portfolio income. tax year. For this purpose, the ratable portion of
ment. Also treat the date you agree to transfer
• Qualified home mortgage interest, capital- an item of deduction or loss is the amount of
your interest for a fixed or determinable amount
ized interest expenses, and other interest such item multiplied by the fraction obtained by
as the disposition date.
expenses (other than self-charged inter- dividing:
If you used the property in more than one
activity during the 12-month period before its est) properly allocable to passive activities. 1. The amount of your share of S corporation
disposition, this exception applies only to the For more information on self-charged inter- loss that’s disallowed for the tax year, by
part of the gain allocated to a passive activity est, see Self-charged interest under Pas-
sive Activity Income and Deductions, ear- 2. The sum of your pro rata shares of all
under the rules described in the preceding dis-
lier. items of deduction and loss of the corpora-
cussion.
• Losses from dispositions of property that tion for the tax year.
Disposition of property converted to inven- produce portfolio income or property held
Proration of deductions disallowed un-
tory. If you disposed of property that you had for investment.
der at-risk limitation. If any amount of your
converted to inventory from its use in another • State, local, and foreign income taxes. loss from an activity (as defined in Activities
activity (for example, you sold condominium • Miscellaneous itemized deductions that Covered by the At-Risk Rules, later) is disal-
units you previously held for use in a rental ac- may be disallowed because of the
lowed under the at-risk rules for the tax year, a
tivity), a special rule may apply. Under this rule, 2%-of-adjusted-gross-income limit.
ratable portion of each item of deduction or loss
you disregard the property's use as inventory • Charitable contribution deductions. from the activity is disallowed for the tax year.
and treat it as if it were still used in that other ac- • Net operating loss deductions. For this purpose, the ratable portion of an item
tivity at the time of disposition. This rule applies • Percentage depletion carryovers for oil and of deduction or loss is the amount of such item
only if you meet all of the following conditions. gas wells.
multiplied by the fraction obtained by dividing:
• At the time of disposition, you held your in- • Capital loss carrybacks and carryovers.
terest in the property in a dealing activity • Items of deduction from a passive activity 1. The amount of the loss from the activity
(an activity that involves holding the prop- that are disallowed under the limits on de- that’s disallowed for the tax year, by
ductions that apply before the passive ac-
Publication 925 (2021) Page 72. The sum of all deductions from the activity Appropriate Economic Units must regroup the activities and comply with any
for the taxable year. disclosure requirements of the IRS.
Generally, to determine if activities form an ap- See Disclosure Requirement, later.
Separately identified items of deduction propriate economic unit, you must consider all
and loss. In identifying the items of deduction the relevant facts and circumstances. You can Regrouping by the IRS. If any of the activities
and loss from an activity that aren’t disallowed use any reasonable method of applying the rel- resulting from your grouping isn’t an appropriate
under the basis and at-risk limitations (and that evant facts and circumstances in grouping ac- economic unit and one of the primary purposes
therefore may be treated as passive activity de- tivities. The following factors have the greatest of your grouping (or failure to regroup) is to
ductions), you needn’t account separately for
DRAFT AS OF
weight in determining whether activities form an avoid the passive activity rules, the IRS may re-
any item of deduction or loss unless such item appropriate economic unit. All of the factors group your activities.
may, if separately taken into account, result in don’t have to apply to treat more than one activ-
an income tax liability different from that which ity as a single activity. The factors that you Rental activities. In general, you can’t group a
would result were such item of deduction or should consider are: rental activity with a trade or business activity.
loss taken into account separately. However, you can group them together if the
Items of deduction or loss that must be ac- 1. The similarities and differences in the
activities form an appropriate economic unit
types of trades or businesses;
November 1, 2021
counted for separately include (but aren’t limi- and:
ted to) items of deduction or loss that: 2. The extent of common control; • The rental activity is insubstantial in rela-
1. Are attributable to separate activities. See tion to the trade or business activity;
3. The extent of common ownership;
Grouping Your Activities, later. • The trade or business activity is insubstan-
4. The geographical location; and tial in relation to the rental activity; or
2. Arise in a rental real estate activity in tax • Each owner of the trade or business activ-
years in which you actively participate in 5. The interdependencies between or among
ity has the same ownership interest in the
such activity. activities, which may include the extent to
rental activity, in which case the part of the
which the activities:
3. Arise in a rental real estate activity in taxa- rental activity that involves the rental of
ble years in which you don’t actively par- a. Buy or sell goods between or among items of property for use in the trade or
ticipate in such activity. themselves, business activity may be grouped with the
trade or business activity.
4. Arose in a taxable year beginning before b. Involve products or services that are
1987 and weren’t allowed for such taxable generally provided together, Example. Herbert and Wilma are married
year under the basis or at-risk limitations. c. Have the same customers, and file a joint return. Healthy Food, an S corpo-
5. Are taken into account under section ration, is a grocery store business. Herbert is
d. Have the same employees, or Healthy Food's only shareholder. Plum Tower,
613A(d) (relating to limitations on certain
depletion deductions). e. Use a single set of books and records an S corporation, owns and rents out the build-
to account for the activities. ing. Wilma is Plum Tower's only shareholder.
6. Are taken into account under section 1211 Plum Tower rents part of its building to Healthy
(relating to the limitation on capital losses). Example 1. John Jackson owns a bakery Food. Plum Tower's grocery store rental busi-
7. Are taken into account under section 1231 and a movie theater at a shopping mall in Balti- ness and Healthy Food's grocery business
(relating to property used in a trade or more and a bakery and movie theater in Phila- aren’t insubstantial in relation to each other.
business and involuntary conversions). delphia. Based on all the relevant facts and cir- Herbert and Wilma file a joint return, so
See Section 1231 Gains and Losses in cumstances, there may be more than one they’re treated as one taxpayer for purposes of
Pub. 544 for more information. reasonable method for grouping John's activi- the passive activity rules. The same owner
ties. For example, John may be able to group (Herbert and Wilma) owns both Healthy Food
8. Are attributable to pre-enactment interests the movie theaters and the bakeries into: and Plum Tower with the same ownership inter-
in activities. See Regulations section • One activity, est (100% in each). If the grouping forms an ap-
1.469-11T(c). • A movie theater activity and a bakery activ- propriate economic unit, as discussed earlier,
ity, Herbert and Wilma can group Plum Tower's
Grouping Your Activities • A Baltimore activity and a Philadelphia ac- grocery store rental and Healthy Food's grocery
tivity, or business into a single trade or business activity.
You can treat one or more trade or business ac- • Four separate activities.
Grouping of real and personal property
tivities, or rental activities, as a single activity if
Example 2. Betty is a partner in ABC part- rentals. In general, you can’t treat an activity
those activities form an appropriate economic
nership, which sells nonfood items to grocery involving the rental of real property and an ac-
unit for measuring gain or loss under the pas-
stores. Betty is also a partner in DEF (a trucking tivity involving the rental of personal property as
sive activity rules.
business). ABC and DEF are under common a single activity. However, you can treat them
Grouping is important for a number of rea- control. The main part of DEF's business is as a single activity if you provide the personal
sons. If you group two activities into one larger transporting goods for ABC. DEF is the only property in connection with the real property or
activity, you need only show material participa- trucking business in which Betty is involved. the real property in connection with the per-
tion in the activity as a whole. But if the two ac- Based on the rules of this section, Betty treats sonal property.
tivities are separate, you must show material ABC's wholesale activity and DEF's trucking ac-
participation in each one. On the other hand, if Certain activities may not be grouped. In
tivity as a single activity.
you group two activities into one larger activity general, if you own an interest as a limited part-
and you dispose of one of the two, then you Consistency and disclosure requirement. ner or a limited entrepreneur in one of the fol-
have disposed of only part of your entire inter- Generally, when you group activities into appro- lowing activities, you may not group that activity
est in the activity. But if the two activities are priate economic units, you may not regroup with any other activity in another type of busi-
separate and you dispose of one of them, then those activities in a later tax year. You must ness.
you have disposed of your entire interest in that meet any disclosure requirements of the IRS • Holding, producing, or distributing motion
activity. when you first group your activities and when picture films or video tapes.
you add or dispose of any activities in your • Farming.
Grouping can also be important in determin-
groupings. • Leasing any section 1245 property (as de-
ing whether you meet the 10% ownership re- fined in section 1245(a)(3) of the Internal
quirement for actively participating in a rental However, if the original grouping is clearly
Revenue Code). For a list of section 1245
real estate activity. inappropriate or there is a material change in
property, see Section 1245 property under
the facts and circumstances that makes the
Activities Covered by the At-Risk Rules,
original grouping clearly inappropriate, you
later.
Page 8 Publication 925 (2021)You can also read
