when you record a loss on a passive activity only passive activity profits can have their deductions offset instead of the income as a whole it would be prudent to ensure that all your passive activities were classified that way to make the most of the tax deduction these are allotted and applied to account for the next year s earnings or losses 13
to save time and effort you can group two or more passive activities into one larger activity if you form an appropriate economic unit according to the irs when you do this instead of providing material participation in several activities you only have to provide it for the activity as a whole in addition if you include several activities in one group and have to dispose of one of those activities then you ve only done away with part of a larger activity as opposed to all of a smaller one 4the organizing principle is that if the activities are located in the same geographic area if the activities have similarities in the types of business or if the activities are somehow interdependent they can be grouped 4let s deal with the specific types of income with special tax considerations investing in a business where you don t materially participate offers the potential for passive income this typically involves putting capital into a venture without involvement in its day to day operations or management decisions the key is that your role is not active your involvement is primarily financial this kind of investment can appeal to those diversifying their income streams but don t have the time to engage in a business themselves the returns are usually generated through profit sharing depending on the entity s business allowing you to benefit from its activity without the demands of actively managing a business whose trade you may know little about here s an example suppose you put 500 000 into a candy store with the agreement that the owners would pay you a percentage of the earnings this would be considered passive income as long as you do not participate in the operation of the business other than investing if you help manage the company or take up the tasty role of eating each type of candy to be sold to recommend what to stock your efforts may count as material participation 5here are the irs s criteria for material participation 5rental properties are defined as passive income with a couple of exceptions if you re a real estate professional any rental income that you re making counts as active income if you re self renting meaning that you own a space and rent it out to a corporation or partnership where you conduct business that also doesn t constitute passive income that s unless the lease was signed before 1988 6income from leasing land does not qualify as passive income either however a landowner can benefit from passive income loss rules if the property nets a loss during the tax year 1