what are passive activity loss rules 
passive activity loss rules are a set of tax regulations that prohibit taxpayers from using passive losses to offset earned or ordinary income the regulations prevent investors from using losses incurred from income producing activities in which they are not materially involved being materially involved with earned or ordinary income producing activities means the income is active income and may not be reduced by passive losses passive losses can be used only to offset passive income 1understanding passive activity loss rulesthe key issue with passive activity loss rules is material participation according to irs topic no 425 material participation is involvement in the operation of a trade or business activity on a regular continuous and substantial basis 2there are seven tests that can define material participation but the most common one is working at least 500 hours in the business in the course of a year 3 if the taxpayer does not materially participate in the activity that is producing the passive losses those losses can be matched only against passive income if there is no passive income no loss can be deducted note that rental activities including real estate rental activities are considered passive activities even if there is material participation real estate professionals have their own rules for determining material participation 4passive income is different from portfolio income portfolio income includes capital gains dividends and interest 5passive activity losses are tax attributes that can only be applied in the current year in most cases however if they exceed passive income they can be carried forward without limitation they cannot be carried back 1passive activity loss rules are generally applied at the individual level but they also extend to virtually all businesses and rental activity in various reporting entities with the exception of c corporations these are designed to deter the abusive use of tax shelters 6there are detailed rules about how much passive loss is deductible 7 if you think these rules could apply to your tax situation consult a tax specialist passive losses and passive activitypassive activity is activity that a taxpayer did not materially participate in during the tax year the internal revenue service irs defines two types of passive activity unless the taxpayer is a real estate professional rental activities usually provide streams of income that are passive the irs defines material participation as involvement in the activity of the business on a regular continuous and substantial basis 9a passive loss is thus a financial loss within an investment in any trade or business enterprise in which the investor is not a material participant passive losses can stem from investments in rental properties business partnerships or other activities in which an investor is not materially involved in order to be considered a non material participant the investor cannot be continuously and substantially active or involved in the business activity 10passive losses and income can come from the following activities though there may be some exceptions in each category if you are unsure whether a loss should be classified as passive or not it is worth consulting with a professional accountant to ensure your taxes are being filed correctly 