Passive Activity

DEFINITION of 'Passive Activity'

Activity in which the taxpayer did not materially participate in during the tax year. Internal Revenue Service (IRS) defines two types of passive activity: trade or business activities not materially participated in, and rental activities even if the taxpayer materially participated in them (unless the taxpayer is a real estate professional). Material participation is defined by the IRS as involvement in the activity of the business on a regular, continuous and substantial basis.

The passive activity rules apply to individuals, estates, trusts (except grantor trusts), closely held corporations, and personal service corporations.

INVESTOPEDIA EXPLAINS 'Passive Activity'

Income from rental properties is a suitable example of a passive activity. Making a distinction between passive and active income is important because the taxpayer can claim a passive loss only against income generated from passive activities. A passive loss cannot be claimed against active income. Any excess passive activity loss can be carried forward to future years until used, or until it can be deducted in the year when the taxpayer disposes of the passive activity in a taxable transaction.

RELATED TERMS
  1. Income

    Money that an individual or business receives in exchange for ...
  2. Active Income

    Income for which services have been performed. This includes ...
  3. Passive Income

    Earnings an individual derives from a rental property, limited ...
  4. Portfolio Income

    Income from investments, dividends, interest, royalties and capital ...
  5. Passive Activity Loss Rules

    A set of rules that prohibits using passive losses to offset ...
  6. Holding Period Return/Yield

    The total return received from holding an asset or portfolio ...
Related Articles
  1. Retirement

    Tax Tips For The Individual Investor

  2. Taxes

    Surviving The IRS Audit

  3. Options & Futures

    Choosing The Best Disability Insurance ...

  4. Taxes

    Capital Gains Tax 101

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Conduit Issuer

    An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects ...
  3. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  4. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  5. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  6. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...