Passive Income

Description:

A term used by the Internal Revenue Service ()IRS Passive Income that means either:

1. A trade or business activity in which the taxpayer does not materially participate in during the year.

2. A rental activity, even if the taxpayer does participate in it. One important exception to this is if the taxpayer is a real estate professional, in which case it is not considered passive activity.

The reason for this term is that passive income has more limits on deductions that can be taken versus active income. Passive activity expenses are only deductible from passive activity income. If the expenses are greater than the income, the taxpayer can't then use these additional expenses to offset other forms of income (payroll, etc.). This is the main benefit to active income: any losses from active income sources can offset other forms of income.

Generally, there are two types of passive activities:

1. Trade or business activities in which the taxpayer participates less than 500 hours per year (referred to as material participation).

2. Rental activities, even if the taxpayer does materially participate in them. There are a few exceptions to this rule, one of which is for active real estate professionals. As with all tax issues, it is best to consult your accountant or contact the IRS directly with questions.