As far as the IRS is concerned, any business you don't "materially participate" in — meaning, actively taking a hand in its operations — is a passive one. If, say, you belong to a limited partnership, put up money but don't actively participate, your income is passive. That's unimportant if you show a profit for the year. If your business runs into the red, however, reporting passive losses on your taxes is different from losses on active income. Generally, you can't deduct passive losses from anything but other passive income. Instead, you carry the loss over to the next year.
Step 1
Add up your income and expenses for the business year, just as you would for a business you materially participate in. Use your regular tax forms to do this -- Schedule C for a business, Schedule E for a rental property, for instance.
Step 2
Download IRS Form 8582. Use the worksheets on the back to add up the total income and loss in different categories, including any losses carried over from last year. If, say, three of your five rental houses turn a profit, you include the total net income from them in one column and the total net losses from the other two in a separate column.
Step 3
Transfer the totals from the different columns on the front of Form 8582. Total them up to get your overall passive loss for the year. If you end up with zero, or a positive total, all your losses are deductible.
Step 4
Enter your losses on Worksheet 5 on Form 8582 if you have a net loss from all passive activities. Add them up, then divide each individual loss by the total. If, say, activity A gives you a $25,000 loss, and B gives you a $75,000 loss -- totaling $100,000 -- you'd have 25 percent and 75 percent as the results.
Step 5
Apply the percentages to your unallowed losses — the red ink you can't write off this year. If activity C turned a $60,000 profit, say, that would offset some of your $100,000 loss from activities A and B, leaving you with $40,000 to carry over.
Step 6
Calculate your carryover amount for different activities. If 25 percent of your losses comes from activity A, then you can apply 25 percent of the carryover -- $10,000 -- to activity A's profits next year. The remaining $30,000 would be applied to B next year.
References
Resources
Tips
- Rental business is always a passive activity unless you're a real-estate professional. However, if you materially participate — arranging for repairs, vetting tenants, advertising vacancies — you can deduct up to $25,000 in losses from your non-passive income.
- Use Worksheet 6 of 8582 to figure carryover losses if you have activities you report on one IRS Schedule. If activities require two schedules to report properly, use Worksheet 7.
Writer Bio
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.