Can I take a tax deduction for a passive activity loss on my tax return?

The passive activity loss rules were enacted in 1986 to prevent individuals from using tax shelters to reduce tax liability on their tax return by offsetting passive activity losses and passive activity tax credits against other taxable income. But the tax rules went beyond that and covered real estate investors and silent partners in businesses.

Identify your passive activity losses and passive activity income such as limited partnership investments and rental activities, which generally include all income or losses other than those related to an active trade or business, or portfolio income (e.g., interest, dividends, royalties, annuities, and gain or loss from the sale of portfolio assets).

In general, passive activity losses can only offset passive activity income, and passive activity tax credits can only be used against tax attributable to passive activity income on your tax return. Any disallowed passive activity losses and passive activity tax credits are tax deferred until passive activity income is generated or the passive activity is disposed of in a taxable transaction.

If your rental of real estate is a passive activity, you may generally offset a passive activity loss of up to $25,000 against your non passive income on your tax return if you actively participate in the passive activity. However, married persons filing separate tax returns who lived together at any time during the tax year may not claim this offset on their tax returns. Married persons filing separate tax returns who lived apart at all times during the tax year are each allowed a $12,500 maximum offset for passive activity real estate on their tax returns. The allowance is phased-out if your modified adjusted gross income is between $100,000 and $150,000.

Phase-out of $25,000 Passive Activity Loss Allowance

If the taxpayer's modified AGI is...

His passive activity loss allowance is...

Up to $100,000 $25,000
$110,000 $20,000
$120,000 $15,000
$130,000 $10,000
$140,000 $5,000
$150,000 or more $0
Special rules apply to persons who perform more than half of their personal services, and more than 750 hours of such services for real property trades or businesses in which they materially participate.
 Related tax information about passive activity losses
IRS publications about passive activity losses:
For additional information on limits on rental losses, refer to Chapter 10 of IRS Publication 17, Your Federal Income Tax, IRS Publication 925, Passive Activity and At-Risk Rules, and  Tax Topic 425, Passive Activities - Losses and Credits.
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