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Rev. date: 11/27/2013

Passive Activities – Losses and Credits

Tax Topic 425
Generally, losses from passive activities that exceed the income from passive activities are disallowed for the current year. Disallowed passive losses are carried forward to the next taxable year. A similar rule applies to credits from passive activities.
Passive activities include trade or business activities in which you do not "materially participate." You materially participate in an activity if you are involved in the operation of the activity on a regular, continuous, and substantial basis. In general, rental activities, including rental real estate activities, are also passive activities, even if you do materially participate. However, rental real estate activities in which you materially participate are not passive activities if you qualify as a "real estate professional." Additionally, there is a limited exception for rental real estate activities in which you "actively participate." The rules for active participation are different from those for material participation. Guidelines for determining material participation, the rules for a real estate professional, active participation, and the special rules that apply to the income and losses from a passive activity held through a publicly traded partnership (PTP) can be found in Publication 925, Passive Activity and At-Risk Rules.
Generally, you may deduct in full any previously disallowed passive activity loss in the year you dispose of your entire interest in the activity. In contrast, you may not claim unused passive activity credits upon disposition of your entire interest in the activity. However, you may elect to increase the basis of the credit property in an amount equal to the portion of the unused credit that previously reduced the basis of the credit property.
Use Form 8582, Passive Activity Loss Limitations, to summarize income and losses from passive activities and to compute the deductible losses. Use Form 8582-CR, Passive Activity Credit Limitations, to summarize the credits from passive activities and to compute the allowed passive activity credit. You may also use 8582-CR to make an election to increase the basis of credit property when you dispose of the property.