Passive Activity Loss Rules

AAA

DEFINITION of 'Passive Activity Loss Rules'

A set of rules that prohibits using passive losses to offset earned or ordinary income. Passive activity loss rules 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.

INVESTOPEDIA EXPLAINS 'Passive Activity Loss Rules'

The key issue with passive activity loss rules is material participation. If the taxpayer does not materially participate in the activity that is producing the passive losses, then those losses can only be declared against passive income. If there is no passive income, then no loss can be deducted.

Passive activity losses can only be carried forward; they cannot be carried back.

RELATED TERMS
  1. Passive Income

    Earnings an individual derives from a rental property, limited ...
  2. Earned Income

    Income derived from active participation in a trade or business, ...
  3. Loss Carryforward

    An accounting technique that applies the current year's net operating ...
  4. Passive Activity

    Activity in which the taxpayer did not materially participate ...
  5. Active Income

    Income for which services have been performed. This includes ...
  6. Passive Loss

    A financial loss within an investment in any trade or business ...
RELATED FAQS
  1. How is accounting in the United States different from international accounting?

    Despite major efforts by the Financial Accounting Standards Board, or FASB, and the International Accounting Standards Board, ... Read Full Answer >>
  2. What is the variance/covariance matrix or parametric method in Value at Risk (VaR)?

    The parametric method, also known as the variance-covariance method, is a risk management technique for calculating the value ... Read Full Answer >>
  3. How are transfer prices set?

    The United States, like most nations, does not want to allow transfer pricing methods that reduce the amount of taxes the ... Read Full Answer >>
  4. What is backtesting in Value at Risk (VaR)?

    The value at risk is a statistical risk management technique that monitors and quantifies the risk level associated with ... Read Full Answer >>
  5. Which financial statements are most important when performing ratio analysis?

    Financial ratio analysis is an important aspect of fundamental analysis for any party engaged in value investing. Financial ... Read Full Answer >>
  6. How do I discount Free Cash Flow to the Firm (FCFF)?

    Discounted free cash flow for the firm (FCFF) should be equal to all of the cash inflows and outflows, adjusted to present ... Read Full Answer >>
Related Articles
  1. Retirement

    Tax Tips For The Individual Investor

    We give you seven guidelines to help you keep more of your money in your pocket.
  2. Options & Futures

    Increase Your Disposable Income

    Here are four quick and easy ways to up your spending money.
  3. Mutual Funds & ETFs

    Active Vs. Passive ETF Investing

    You can use these securities for more than just indexing. Explore the spectrum of possible ETF strategies.
  4. Options & Futures

    3 Simple Steps To Building Wealth

    Getting richer is easier if you take it one step at a time.
  5. Retirement

    Why It Pays To Be A Lazy Investor

    Be a couch potato! This passive, but diversified, investing strategy could be for you.
  6. Active Trading

    Seek Out Past Losses To Uncover Future Gains

    Tax loss carry-forwards can help reduce the tax burden of owning a profitable fund.
  7. Economics

    Understanding Carrying Value

    Carrying value is the value of an asset as listed on a company’s balance sheet. Carrying value is the same as book value.
  8. Economics

    International Financial Reporting Standards (IFRS)

    International Financial Reporting Standards are accounting rules and guidelines governing the reporting of different types of accounting transactions.
  9. Economics

    Explaining Property, Plant and Equipment

    Property, plant and equipment are company assets that are vital to business operations, but not easily liquidated.
  10. Economics

    How to Calculate Trailing 12 Months Income

    Trailing 12 months refers to the most recently completed one-year period of a company’s financial performance.

You May Also Like

Hot Definitions
  1. Venture-Capital-Backed IPO

    The selling to the public of shares in a company that has previously been funded primarily by private investors. The alternative ...
  2. Merger Arbitrage

    A hedge fund strategy in which the stocks of two merging companies are simultaneously bought and sold to create a riskless ...
  3. Market Failure

    An economic term that encompasses a situation where, in any given market, the quantity of a product demanded by consumers ...
  4. Unsystematic Risk

    Company or industry specific risk that is inherent in each investment. The amount of unsystematic risk can be reduced through ...
  5. Security Market Line - SML

    A line that graphs the systematic, or market, risk versus return of the whole market at a certain time and shows all risky ...
  6. Tangible Net Worth

    A measure of the physical worth of a company, which does not include any value derived from intangible assets such as copyrights, ...
Trading Center