26 USC 469 - Passive activity losses and credits limited

View all text of Subpart C [§ 461 - § 470]

§ 469. Passive activity losses and credits limited

(a) Disallowance

(1) In generalIf for any taxable year the taxpayer is described in paragraph (2), neither—

(A) the passive activity loss, nor

(B) the passive activity credit,

for the taxable year shall be allowed.

(2) Persons describedThe following are described in this paragraph:

(A) any individual, estate, or trust,

(B) any closely held C corporation, and

(b) Disallowed loss or credit carried to next year

(1) In generalThe term “passive activity” means any activity—

(A) which involves the conduct of any trade or business, and

(B) in which the taxpayer does not materially participate.

(2) Passive activity includes any rental activity

(3) Working interests in oil and gas property

(A) In general

(B) Income in subsequent years

(4) Material participation not required for paragraphs (2) and (3)

(5) Trade or business includes research and experimentation activity

(6) Activity in connection with trade or business or production of incomeTo the extent provided in regulations, for purposes of paragraph (1)(A), the term “trade or business” includes—

(A) any activity in connection with a trade or business, or

(B) any activity with respect to which expenses are allowable as a deduction under section 212.

(7) Special rules for taxpayers in real property business

(A) In generalIf this paragraph applies to any taxpayer for a taxable year—

(i) paragraph (2) shall not apply to any rental real estate activity of such taxpayer for such taxable year, and

(ii) this section shall be applied as if each interest of the taxpayer in rental real estate were a separate activity.

Notwithstanding clause (ii), a taxpayer may elect to treat all interests in rental real estate as one activity. Nothing in the preceding provisions of this subparagraph shall be construed as affecting the determination of whether the taxpayer materially participates with respect to any interest in a limited partnership as a limited partner.

(B) Taxpayers to whom paragraph appliesThis paragraph shall apply to a taxpayer for a taxable year if—

(i) more than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and

(ii) such taxpayer performs more than 750 hours of services during the taxable year in real property trades or businesses in which the taxpayer materially participates.

In the case of a joint return, the requirements of the preceding sentence are satisfied if and only if either spouse separately satisfies such requirements. For purposes of the preceding sentence, activities in which a spouse materially participates shall be determined under subsection (h).

(D) Special rules for subparagraph (B)

(i) Closely held C corporations

(ii) Personal services as an employee

(d) Passive activity loss and credit definedFor purposes of this section—

(1) Passive activity lossThe term “passive activity loss” means the amount (if any) by which—

(A) the aggregate losses from all passive activities for the taxable year, exceed

(B) the aggregate income from all passive activities for such year.

(2) Passive activity creditThe term “passive activity credit” means the amount (if any) by which—

(A) the sum of the credits from all passive activities allowable for the taxable year under—

(i) subpart D of part IV of subchapter A, or

(ii) subpart B (other than section 27) of such part IV, exceeds

(B) the regular tax liability of the taxpayer for the taxable year allocable to all passive activities.

(e) Special rules for determining income or loss from a passive activityFor purposes of this section—

(1) Certain income not treated as income from passive activityIn determining the income or loss from any activity—

(A) In generalThere shall not be taken into account—

(i) any—(I) gross income from interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business,(II) expenses (other than interest) which are clearly and directly allocable to such gross income, and(III) interest expense properly allocable to such gross income, and

(ii) gain or loss not derived in the ordinary course of a trade or business which is attributable to the disposition of property—(I) producing income of a type described in clause (i), or(II) held for investment.

For purposes of clause (ii), any interest in a passive activity shall not be treated as property held for investment.

(B) Return on working capital

(2) Passive losses of certain closely held corporations may offset active income

(A) In generalIf a closely held C corporation (other than a personal service corporation) has net active income for any taxable year, the passive activity loss of such taxpayer for such taxable year (determined without regard to this paragraph)—

(i) shall be allowable as a deduction against net active income, and

(ii) shall not be taken into account under subsection (a) to the extent so allowable as a deduction.

A similar rule shall apply in the case of any passive activity credit of the taxpayer.

(B) Net active incomeFor purposes of this paragraph, the term “net active income” means the taxable income of the taxpayer for the taxable year determined without regard to—

(i) any income or loss from a passive activity, and

(ii) any item of gross income, expense, gain, or loss described in paragraph (1)(A).

(3) Compensation for personal services

(4) Dividends reduced by dividends received deduction

(f) Treatment of former passive activitiesFor purposes of this section—

(1) In generalIf an activity is a former passive activity for any taxable year—

(A) any unused deduction allocable to such activity under subsection (b) shall be offset against the income from such activity for the taxable year,

(B) any unused credit allocable to such activity under subsection (b) shall be offset against the regular tax liability (computed after the application of paragraph (1)) allocable to such activity for the taxable year, and

(C) any such deduction or credit remaining after the application of subparagraphs (A) and (B) shall continue to be treated as arising from a passive activity.

(2) Change in status of closely held C corporation or personal service corporation

(3) Former passive activityThe term “former passive activity” means any activity which, with respect to the taxpayer—

(A) is not a passive activity for the taxable year, but

(B) was a passive activity for any prior taxable year.

(g) Dispositions of entire interest in passive activityIf during the taxable year a taxpayer disposes of his entire interest in any passive activity (or former passive activity), the following rules shall apply:

(1) Fully taxable transaction

(A) In generalIf all gain or loss realized on such disposition is recognized, the excess of—

(i) any loss from such activity for such taxable year (determined after the application of subsection (b)), over

(ii) any net income or gain for such taxable year from all other passive activities (determined after the application of subsection (b)),

shall be treated as a loss which is not from a passive activity.

(B) Subparagraph (A) not to apply to disposition involving related party

(2) Disposition by deathIf an interest in the activity is transferred by reason of the death of the taxpayer—

(A) paragraph (1)(A) shall apply to losses described in paragraph (1)(A) to the extent such losses are greater than the excess (if any) of—

(i) the basis of such property in the hands of the transferee, over

(ii) the adjusted basis of such property immediately before the death of the taxpayer, and

(B) any losses to the extent of the excess described in subparagraph (A) shall not be allowed as a deduction for any taxable year.

(3) Installment sale of entire interest

(h) Material participation definedFor purposes of this section—

(1) In generalA taxpayer shall be treated as materially participating in an activity only if the taxpayer is involved in the operations of the activity on a basis which is—

(A) regular,

(B) continuous, and

(2) Interests in limited partnerships

(3) Treatment of certain retired individuals and surviving spouses

(4) Certain closely held C corporations and personal service corporationsA closely held C corporation or personal service corporation shall be treated as materially participating in an activity only if—

(A) 1 or more shareholders holding stock representing more than 50 percent (by value) of the outstanding stock of such corporation materially participate in such activity, or

(B) in the case of a closely held C corporation (other than a personal service corporation), the requirements of section 465(c)(7)(C) (without regard to clause (iv)) are met with respect to such activity.

(5) Participation by spouse

(i) $25,000 offset for rental real estate activities

(1) In general

(2) Dollar limitation

(3) Phase-out of exemption

(A) In general

(B) Special phase-out of rehabilitation credit

(D) Ordering ruleParagraph (1) shall be applied for any taxable year—

(i) first, to the passive activity loss,

(ii) second, to the portion of the passive activity credit to which subparagraph (B) and 1

1 So in original. Probably should be “or”.

(iii) third, to the portion of such credit to which subparagraph (B) applies, and

(iv) then, to the portion of such credit to which subparagraph (C) applies.

(E) Adjusted gross incomeFor purposes of this paragraph, adjusted gross income shall be determined without regard to—

(i) any amount includible in gross income under section 86,

(ii) the amounts excludable from gross income under sections 85(c), 135, and 137,

(iii) the amounts allowable as a deduction under sections 219, 221, and 250, and

(iv) any passive activity loss or any loss allowable by reason of subsection (c)(7).

(4) Special rule for estates

(A) In general

(B) Reduction for surviving spouse’s exemption

(5) Married individuals filing separately

(A) In generalExcept as provided in subparagraph (B), in the case of any married individual filing a separate return, this subsection shall be applied by substituting—

(i) “$12,500” for “$25,000” each place it appears,

(ii) “$50,000” for “$100,000” in paragraph (3)(A), and

(iii) “$100,000” for “$200,000” in paragraph (3)(B).

(B) Taxpayers not living apartThis subsection shall not apply to a taxpayer who—

(i) is a married individual filing a separate return for any taxable year, and

(ii) does not live apart from his spouse at all times during such taxable year.

(6) Active participation

(A) In general

(B) No participation requirement for low-income housing or rehabilitation creditParagraphs (1) and (4)(A) shall be applied without regard to the active participation requirement in the case of—

(i) any credit determined under section 42 for any taxable year, or

(ii) any rehabilitation credit determined under section 47,2

(D) Participation by spouse

(j) Other definitions and special rulesFor purposes of this section—

(1) Closely held C corporation

(2) Personal service corporationThe term “personal service corporation” has the meaning given such term by section 269A(b)(1), except that section 269A(b)(2) shall be applied—

(A) by substituting “any” for “more than 10 percent”, and

(B) by substituting “any” for “50 percent or more in value” in section 318(a)(2)(C).

A corporation shall not be treated as a personal service corporation unless more than 10 percent of the stock (by value) in such corporation is held by employee-owners (within the meaning of section 269A(b)(2), as modified by the preceding sentence).

(3) Regular tax liability

(4) Allocation of passive activity loss and credit

(5) Deduction equivalent

(6) Special rule for giftsIn the case of a disposition of any interest in a passive activity by gift—

(A) the basis of such interest immediately before the transfer shall be increased by the amount of any passive activity losses allocable to such interest with respect to which a deduction has not been allowed by reason of subsection (a), and

(B) such losses shall not be allowable as a deduction for any taxable year.

(7) Qualified residence interest

(8) Rental activity

(9) Election to increase basis of property by amount of disallowed credit

(10) Coordination with section 280A

(11) Aggregation of members of affiliated groups

(12) Special rule for distributions by estates or trustsIf any interest in a passive activity is distributed by an estate or trust—

(A) the basis of such interest immediately before such distribution shall be increased by the amount of any passive activity losses allocable to such interest, and

(B) such losses shall not be allowable as a deduction for any taxable year.

(k) Separate application of section in case of publicly traded partnerships

(1) In general

(2) Publicly traded partnershipFor purposes of this section, the term “publicly traded partnership” means any partnership if—

(A) interests in such partnership are traded on an established securities market, or

(B) interests in such partnership are readily tradable on a secondary market (or the substantial equivalent thereof).

(3) Coordination with subsection (g)

(4) Application to regulated investment companies

(l) RegulationsThe Secretary shall prescribe such regulations as may be necessary or appropriate to carry out provisions of this section, including regulations—

(1) which specify what constitutes an activity, material participation, or active participation for purposes of this section,

(2) which provide that certain items of gross income will not be taken into account in determining income or loss from any activity (and the treatment of expenses allocable to such income),

(3) requiring net income or gain from a limited partnership or other passive activity to be treated as not from a passive activity,

(4) which provide for the determination of the allocation of interest expense for purposes of this section, and

(5) which deal with changes in marital status and changes between joint returns and separate returns.

(Added Pub. L. 99–514, title V, § 501(a), Oct. 22, 1986, 100 Stat. 2233; amended Pub. L. 100–203, title X, § 10212(a), Dec. 22, 1987, 101 Stat. 1330–405; Pub. L. 100–647, title I, § 1005(a)(1)–(9), (11), (12), title II, § 2004(g), title VI, § 6009(c)(3), Nov. 10, 1988, 102 Stat. 3387–3389, 3603, 3690; Pub. L. 101–239, title VII, § 7109(a), Dec. 19, 1989, 103 Stat. 2322; Pub. L. 101–508, title XI, §§ 11704(a)(6), 11813(b)(16), Nov. 5, 1990, 104 Stat. 1388–518, 1388–555; Pub. L. 103–66, title XIII, § 13143(a), (b), Aug. 10, 1993, 107 Stat. 440, 441; Pub. L. 104–188, title I, §§ 1704(d)(1), (e)(1), 1807(c)(4), Aug. 20, 1996, 110 Stat. 1878, 1902; Pub. L. 105–277, div. J, title IV, § 4003(a)(2)(D), Oct. 21, 1998, 112 Stat. 2681–908; Pub. L. 106–554, § 1(a)(7) [title I, § 101(b)], Dec. 21, 2000, 114 Stat. 2763, 2763A–599; Pub. L. 107–16, title IV, § 431(c)(3), June 7, 2001, 115 Stat. 68; Pub. L. 107–147, title IV, § 412(a), Mar. 9, 2002, 116 Stat. 53; Pub. L. 108–357, title I, § 102(d)(5), title III, § 331(g), Oct. 22, 2004, 118 Stat. 1429, 1477; Pub. L. 113–295, div. A, title II, § 221(a)(41)(G), (60)(A), Dec. 19, 2014, 128 Stat. 4044, 4047; Pub. L. 115–97, title I, §§ 13305(b)(1), 14202(b)(3), Dec. 22, 2017, 131 Stat. 2126, 2216; Pub. L. 115–141, div. U, title IV, § 401(d)(1)(D)(ii), (5)(B)(i)–(iii), Mar. 23, 2018, 132 Stat. 1206, 1210; Pub. L. 116–260, div. EE, title I, § 104(b)(2)(H), Dec. 27, 2020, 134 Stat. 3041; Pub. L. 117–2, title IX, § 9042(b)(8), Mar. 11, 2021, 135 Stat. 122.)