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H&r Blocks

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H&r Blocks

H&r blocks 9. H&r blocks   Figuring Net Profit or Loss Table of Contents Introduction Net Operating Losses (NOLs) Not-for-Profit Activities Introduction After figuring your business income and expenses, you are ready to figure the net profit or net loss from your business. H&r blocks You do this by subtracting business expenses from business income. H&r blocks If your expenses are less than your income, the difference is net profit and becomes part of your income on page 1 of Form 1040. H&r blocks If your expenses are more than your income, the difference is a net loss. H&r blocks You usually can deduct it from gross income on page 1 of Form 1040. H&r blocks But in some situations your loss is limited. H&r blocks This chapter briefly explains two of those situations. H&r blocks Other situations that may limit your loss are explained in the Instructions for Schedule C, line G and line 32. H&r blocks If you have more than one business, you must figure your net profit or loss for each business on a separate Schedule C. H&r blocks Net Operating Losses (NOLs) If your deductions for the year are more than your income for the year (line 41 of your Form 1040 is a negative number), you may have a net operating loss (NOL). H&r blocks You can use an NOL by deducting it from your income in another year or years. H&r blocks Examples of typical losses that may produce an NOL include, but are not limited to, losses incurred from the following. H&r blocks Your trade or business. H&r blocks Your work as an employee (unreimbursed employee business expenses). H&r blocks A casualty or theft. H&r blocks Moving expenses. H&r blocks Rental property. H&r blocks A loss from operating a business is the most common reason for an NOL. H&r blocks For details about NOLs, see Publication 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts. H&r blocks It explains how to figure an NOL, when to use it, how to claim an NOL deduction, and how to figure an NOL carryover. H&r blocks Not-for-Profit Activities If you do not carry on your business to make a profit, there is a limit on the deductions you can take. H&r blocks You cannot use a loss from the activity to offset other income. H&r blocks Activities you do as a hobby, or mainly for sport or recreation, come under this limit. H&r blocks For details about not-for-profit activities, see chapter 1 in Publication 535, Business Expenses. H&r blocks That chapter explains how to determine whether your activity is carried on to make a profit and how to figure the amount of loss you can deduct. H&r blocks Prev  Up  Next   Home   More Online Publications
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Updated: Common Input Issues

Many common issues are easy to resolve by following the instructions below. The most frequent issue involves data entry errors.  Please review your return closely before e-filing.  Because Free File Fillable Forms is basic, you must follow the instructions exactly and enter data only on the lines indicated.

Below you will find a few more general tips for successful e-filing and then some more specific issues currently trending for Free File Fillable Forms:

General Tips

  • Many issues can be resolved by simply using the “tab” key which ensures you will see all the data boxes. For example, when you use the tab key, you will see the MI box for your middle initial on the top of the Form 1040.
  • Use the state drop down box in the address field and enter zip code in appropriate box.
  • Check all your data entries before attempting to e-file.
  • Check your social security numbers for accuracy.  Is your dependent’s SSN correct? Is your SSN correct on the Form W2, Box A, Employee’s SSN?
  • Do not use zero “0” in any field unless instructed to do so.
  • If you’re getting a refund by direct deposit, double check your financial account and routing numbers; the routing number must be nine digits.  Be sure to select checking or savings. 
  • Check your withholdings; make sure your W-2 statement withholdings match the amount on your 1040.
  • Check the withholding amount entered Step 2, Section 1 and make sure it equals the amount in Step 2, Section 2, Box A.
  • Verify your identity. Do not guess at your prior year Adjusted Gross Income. This is the most common error we see. If you don’t remember your AGI, you must get an electronic filing PIN at IRS.gov or call 1-866-704-7388.
  • If your filing status is Married Filing Jointly, make sure to include all information for your spouse, especially Step 2 requirements for identify verification and signing the return electronically.
  •  Whenever you’re entering your information on a form or schedule in Free File Fillable Forms and you have a question, just select the button, "Instructions For This Form," at the bottom of the screen.

Specific Issues

I didn’t get the email confirming that my Free File Fillable Forms return was accepted or rejected

  • First, check your email spam/junk folder. 
  • If it’s not there, take the following steps: Return to your Free File Fillable Forms account. (Either through IRS.gov/freefile or freefilefillableforms.com.) 
  • Select “Get E-File Status” from upper left column. If there is no status update, log-on to your account and review your return for accuracy  
  • CAUTION: Make sure to place the current date ("Today's Date") in Step 2, Section 4, Signing This Year's Return
  • Next, select  “E-File Now” button to resubmit.  
  • If your return was successfully e-filed, you will receive 2 emails: one from freefilefillableforms.com saying it was received and a second one from freefilefillableform.com saying it was accepted or rejected by the IRS. If you do not receive these two emails, you have not successfully transmitted your return.

I got this message: Business Rule X0000-005 - The XML data has failed schema validation

This currently is the second most common error we see, and it’s not as scary as it sounds. You will receive this message when there is a data entry error. This is a simple correction.

  • First, your message will identify the form and line number where the error occurred on your return.
  • Look for one of two key phrases in the error message.
  • If you see the phrase “is expected” that means you left blank a required field.
  • If you see the phrase “not facet-valid with” that means you made an entry in the wrong format, i.e. you used a number where it should be blank, or used a description not allowed in the field.
  • For more information, see our Rejected return help page.

“Do the Math” won’t work

Most often, your form is missing data that the program considers necessary to perform the calculation. Use the “tab” key and double check your entries.

Here's a list of some common problems taxpayers have encountered and possible solutions. 

  • 1040 (Form) Line 44 Tax - You must look up your tax in the tax tables and follow the IRS instructions to manually enter an amount on this line.  Don’t forget this step.
  • Schedule 8812 Additional Child Tax Credit, Lines 9, 11, 12 and 13 - You must complete all the prior required lines, including the buttons on line 6, before these lines will calculate.   Check your entries before you e-file.
  • Form 8863, Education Credits (Hope and Lifetime Learning Credits, Line 15 - You are required to complete Part 1. If instructed to put a zero on a line, you must put a zero on that line.
  • Schedule A, Itemized Deductions
    • Line 23 - The amount for this line is populated from the amount(s) you enter in the grey areas under the words, ‘list type and amount’. There are two lines under these words and two fields on each line. The first field is for a description of the ‘Other Expense’ deduction and the second field is for the amount. Enter the description and corresponding amount and ‘Do the math’ will calculate an amount for line 23.
    • Line 29 - Don't forget to manually enter the total amount for your Itemized Deductions on line 29 of the Schedule A.  Line 29 is not a Do the Math calculated field.  Select the “Yes” or “No” button for line 29 and follow the Schedule A instructions for entering an amount on the line 29.  If your answer is No,  Is Form 1040 line 38 over $150,000, then add up all the column amounts, lines 4 through 28, on the Sch A and enter the total amount on line 29.  Check your math.  If  your answer is Yes, line 38 of the Form 1040 is over $150,000 refer to the Itemized Deductions Worksheet for line 29 (page A-13) and then enter the amount you figured on line 29.  After you enter your amount on line 29, then select “Do the Math.”  The amount on line 29 will then transfer and update Line 40 of Form 1040.
  • Schedule C, Profit or Loss from Business Lines 3, 4, 5, and 7 - You must enter the business entity information (A-J) before the lines will calculate.
  • Schedule C-EZ Net Profit or Loss from Business Line 3 - You must enter the business entity information (A-G) before “Do the Math” will calculate.
  • Schedule E, Supplemental Income and Loss, Line 23a, b, etc. - Many lines will not calculate until Part 1 of the form is complete. 

I Can’t Find the Form I need

First, review the list of available Forms You Can Use. You can learn how to add some forms to your return by following the instructions below.

  • Form 4562, Depreciation and Amortization (Including Information on Listed Property -  You must Add the Form 4562 from the “add” button on your Schedule C and/or Schedule E.  You can NOT add the Form 4562 from the “add/view" button.  
  • Form 6198 At-Risk Limitations- Add this form from the “add” button on your Schedule C.
  • Form 8829 Expenses for Business Use of Your Home- Add this form from the “add” button on your line 30 of the Schedule C, Profit or Loss from Business
  • Form 8863, Education Credits (Hope and Lifetime Learning Credits) -
    1. Part III on page 2 for each student for whom you are claiming either credit must be completed before you complete Parts I and II on Page 1.  Some taxpayers can’t find the add button for page 2.  Just go to the top of page 1 of the Form 8863 and click on the add button next to the statement click to enter student information on page 2. 
    2. Make sure you use"Do the Math" for computing line 15 of page 1 of the Form 8863.
    3. Make sure you use the tab key for entering the student’s first name and the last name on line 20. Entered the first name in the first grey field and then use the tab key to enter the last name in the grey field to the right. 
  • Form 8949, Sales and other Dispositions of Capital Assets- Don’t forget to add Page 2 to complete this form.  Complete the Form 8949 before you complete your Schedule D. On the Schedule D, complete lines 1b, 2, 3, 8b, 9, and 10. You may add multiple copies of the Form 8949 if you need additional space to report sales and exchanges of your capital assets.
  • Add Forms W2, W2G and 1099-R in Step 2, Section 1.
  • All other Form 1099’s, including SSA 1099, 1099 INT, 1099 MISC etc. are not available as individual forms in Free File Fillable Forms because you do not have to e-file these statements to IRS.
  • BUT make sure to include all other income from Form 1099 including SSA 1099, 1099 INT, 1099 MISC etc. on your Form 1040. Don’t forget to include your federal withholding amounts from these other Form 1099s in Step 2 Section 2 Box B.

I Can’t Print My Return?

  • If you are having trouble printing and you are using Internet Explorer 8.0 you must upgrade your Internet browser or switch to another computer to print your information.  
  • If you can't print, search for 'print' in General FAQs (PDF) for additional information. Remember, always print your return for your records after you successfully e-file.

I am having problems with my 16a and 16b entries for pensions and annuities on the Form 1040

  • Find your total pension or annuity amount on your Form 1099-R and enter it on line 16a of your Form 1040.
  • Then, enter the taxable portion in 16b to the far right under the column of the Form 1040 where you are entering all of your amounts.
  • Do not enter your taxable amount after “b Taxable amount”.   This “b Taxable amount” field is only reserved for the text: “ROLLOVER”, “PSO”, and “ROLLOVER AND PSO” - Refer to the 1040 instructions to see if either of these 3 descriptions apply to you.
  • When your total pensions and annuities equal your taxable amount, “Do the Math” will automatically remove your amount on line 16a.
  • When your total pensions and annuities is greater than your taxable amount, “Do the Math” will display the total on line 16a and taxable amount you entered to the right of 16b.     

I am getting an error on Line 21, "Other income" on the Form 1040 - List type and amount

  • In certain situations, the form instructions may prompt you to enter information next to a line.   There are 2 parts for you to enter: 1) the description type in the first grey box and then 2) a corresponding amount in the second grey box.  Don’t enter descriptions or $ amounts in the grey fields unless the instructions tell you too.  Generally, leave these fields blank and don't enter a zero or '0" amount unless the instructions tell you too.
  •  Use line 21 of the Form 1040 to report any other taxable income not reported elsewhere on your return or on other schedules.  Make sure you enter the type and then the amount for the Other income to the left of the amount on line 21.  Enter the type of income in the first grey field and then enter the amount in the second grey field.   After you enter the amount in the second grey field, select "Do the Math" and the amount you entered to the left in the grey field will transfer to line 21.   Don't forget to enter the type of other income such as gambling winnings or jury duty pay in the first grey field to the left of the amount.  And if one of your other income description types is net operating loss (NOL), make sure you enter a negative sign "-" before the amount.  To view a list of description types for other income examples on line 21, refer to page 28 of the Form 1040 instructions.  Free File Fillable Forms will automatically display the description type in all upper case letters after selecting Do the Math.

Refer to the tutorial for basic tips before your start Free File Fillable Forms. These tips will improve your chances to successfully e-file without getting errors.

Page Last Reviewed or Updated: 26-Feb-2014

The H&r Blocks

H&r blocks Publication 925 - Main Content Table of Contents Passive Activity LimitsWho Must Use These Rules? Passive Activity Loss Passive Activity Credit Publicly Traded Partnership Excess Farm Loss Passive Activities Activities That Are Not Passive Activities Passive Activity Income and Deductions Grouping Your Activities Recharacterization of Passive Income Dispositions How To Report Your Passive Activity Loss Comprehensive ExampleGeneral Information At-Risk LimitsWho Is Affected? Activities Covered by the At-Risk Rules At-Risk Amounts Amounts Not At Risk Reductions of Amounts At Risk Recapture Rule How To Get Tax HelpLow Income Taxpayer Clinics Passive Activity Limits Who Must Use These Rules? The passive activity rules apply to: Individuals, Estates, Trusts (other than grantor trusts), Personal service corporations, and Closely held corporations. H&r blocks Even though the rules do not apply to grantor trusts, partnerships, and S corporations directly, they do apply to the owners of these entities. H&r blocks For information about personal service corporations and closely held corporations, including definitions and how the passive activity rules apply to these corporations, see Form 8810 and its instructions. H&r blocks Before applying the passive activity limits, you must first determine the amount of the deductions disallowed under the basis, excess farm loss, or at-risk rules. H&r blocks See Passive Activity Deductions, later. H&r blocks Passive Activity Loss Generally, the passive activity loss for the tax year is not allowed. H&r blocks However, there is a special allowance under which some or all of your passive activity loss may be allowed. H&r blocks See Special $25,000 allowance , later. H&r blocks Definition of passive activity loss. H&r blocks    Generally, your passive activity loss for the tax year is the excess of your passive activity deductions over your passive activity gross income. H&r blocks See Passive Activity Income and Deductions , later. H&r blocks   For a closely held corporation, the passive activity loss is the excess of passive activity deductions over the sum of passive activity gross income and net active income. H&r blocks For details on net active income, see the Instructions for Form 8810. H&r blocks For the definition of passive activity gross income, see Passive Activity Income , later. H&r blocks For the definition of passive activity deductions, see Passive Activity Deductions , later. H&r blocks Identification of Disallowed Passive Activity Deductions If all or a part of your passive activity loss is disallowed for the tax year, you may need to allocate the disallowed passive activity loss among different passive activities and among different deductions within a passive activity. H&r blocks Allocation of disallowed passive activity loss among activities. H&r blocks   If all or any part of your passive activity loss is disallowed for the tax year, a ratable portion of the loss (if any) from each of your passive activities is disallowed. H&r blocks The ratable portion of a loss from an activity is computed by multiplying the passive activity loss that is disallowed for the tax year by the fraction obtained by dividing: The loss from the activity for the tax year; by The sum of the losses for the tax year from all activities having losses for the tax year. H&r blocks Use Worksheet 5 of Form 8582 to figure the ratable portion of the loss from each activity that is disallowed. H&r blocks Loss from an activity. H&r blocks   The term “loss from an activity” means: The amount by which the passive activity deductions (defined later) from the activity for the tax year exceed the passive activity gross income (defined later) from the activity for the tax year; reduced by Any part of such amount that is allowed under the Special $25,000 Allowance , later. H&r blocks   If your passive activity gross income from significant participation passive activities (defined later) for the tax year is more than your passive activity deductions from those activities for the tax year, those activities shall be treated, solely for purposes of figuring your loss from the activity, as a single activity that does not have a loss for such taxable year. H&r blocks See Significant Participation Passive Activities , later. H&r blocks Example. H&r blocks John Pine holds interests in three passive activities, A, B, and C. H&r blocks The gross income and deductions from these activities for the taxable year are as follows:   A B C Total Gross income $7,000 $4,000 $12,000 $23,000 Deductions (16,000) (20,000) (8,000) (44,000)           Net income (loss) ($9,000) ($16,000) $4,000 ($21,000)   John Pine’s $21,000 passive activity loss for the taxable year is disallowed. H&r blocks Therefore, a ratable portion of the losses from activities A and B is disallowed. H&r blocks He figures the disallowed portion of each loss as follows: A: $21,000 x $9,000/$25,000 $7,560 B: $21,000 x $16,000/$25,000 13,440     Total $21,000 Allocation within loss activities. H&r blocks   If all or any part of your loss from an activity is disallowed under Allocation of disallowed passive activity loss among activities for the tax year, a ratable portion of each of your passive activity deductions (defined later), other than an excluded deduction (defined below) from such activity is disallowed. H&r blocks The ratable portion of a passive activity deduction is the amount of the disallowed portion of the loss from the activity for the tax year multiplied by the fraction obtained by dividing: The amount of such deduction; by The sum of all of your passive activity deductions (other than excluded deductions) from that activity from the tax year. H&r blocks Excluded deductions. H&r blocks    “Excluded deduction” means any passive activity deduction that is taken into account in computing your net income from an item of property for a taxable year in which an amount of the taxpayer's gross income from such item of property is treated as not from a passive activity. H&r blocks See Recharacterization of Passive Income , later. H&r blocks Separately identified deductions. H&r blocks   In identifying the deductions from an activity that are disallowed, you do not need to account separately for a deduction unless such deduction may, if separately taken into account, result in an income tax liability for any tax year different from that which would result were such deduction not taken into account separately. H&r blocks   Use Form 8582, Worksheet 7, for any activity if you have passive activity deductions for that activity that must be separately identified. H&r blocks   Deductions that must be accounted for separately include (but are not limited to) the following deductions. H&r blocks Deductions that arise in a rental real estate activity in tax years in which you actively participate in such activity. H&r blocks See Active participation , later. H&r blocks Deductions that arise in a rental real estate activity in tax years in which you do not actively participate in such activity. H&r blocks See Active participation , later. H&r blocks Losses from sales or exchanges of capital assets. H&r blocks Section 1231 losses. H&r blocks See Section 1231 Gains and Losses in Publication 544, Sales and Other Disposition of Assets, for more information. H&r blocks Carryover of Disallowed Deductions In the case of an activity with respect to which any deductions or credits are disallowed for a taxable year (the loss activity), the disallowed deductions are allocated among your activities for the next tax year in a manner that reasonably reflects the extent to which each activity continues the loss activity. H&r blocks The disallowed deductions or credits allocated to an activity under the preceding sentence are treated as deductions or credits from the activity for the next tax year. H&r blocks For more information, see Regulations section 1. H&r blocks 469-1(f)(4). H&r blocks Passive Activity Credit Generally, the passive activity credit for the tax year is disallowed. H&r blocks The passive activity credit is the amount by which the sum of all your credits subject to the passive activity rules exceed your regular tax liability allocable to all passive activities for the tax year. H&r blocks Credits that are included in figuring the general business credit are subject to the passive activity rules. H&r blocks See the Instructions for Form 8582-CR for more information. H&r blocks Publicly Traded Partnership You must apply the rules in this part separately to your income or loss from a passive activity held through a publicly traded partnership (PTP). H&r blocks You also must apply the limit on passive activity credits separately to your credits from a passive activity held through a PTP. H&r blocks You can offset deductions from passive activities of a PTP only against income or gain from passive activities of the same PTP. H&r blocks Likewise, you can offset credits from passive activities of a PTP only against the tax on the net passive income from the same PTP. H&r blocks This separate treatment rule also applies to a regulated investment company holding an interest in a PTP for the items attributable to that interest. H&r blocks For more information on how to apply the passive activity loss rules to PTPs, and on how to apply the limit on passive activity credits to PTPs, see Publicly Traded Partnerships (PTPs) in the Instructions for Forms 8582 and 8582-CR, respectively. H&r blocks Excess Farm Loss If you receive an applicable subsidy for any tax year and you have an excess farm loss for the tax year, special rules apply. H&r blocks These rules do not apply to C corporations. H&r blocks For information, see the Instructions for Schedule F (Form 1040), Profit or Loss From Farming. H&r blocks Passive Activities There are two kinds of passive activities. H&r blocks Trade or business activities in which you do not materially participate during the year. H&r blocks Rental activities, even if you do materially participate in them, unless you are a real estate professional. H&r blocks Material participation in a trade or business is discussed later, under Activities That Are Not Passive Activities . H&r blocks Treatment of former passive activities. H&r blocks   A former passive activity is an activity that was a passive activity in any earlier tax year, but is not a passive activity in the current tax year. H&r blocks You can deduct a prior year's unallowed loss from the activity up to the amount of your current year net income from the activity. H&r blocks Treat any remaining prior year unallowed loss like you treat any other passive loss. H&r blocks   In addition, any prior year unallowed passive activity credits from a former passive activity offset the allocable part of your current year tax liability. H&r blocks The allocable part of your current year tax liability is that part of this year's tax liability that is allocable to the current year net income from the former passive activity. H&r blocks You figure this after you reduce your net income from the activity by any prior year unallowed loss from that activity (but not below zero). H&r blocks Trade or Business Activities A trade or business activity is an activity that: Involves the conduct of a trade or business (that is, deductions would be allowable under section 162 of the Internal Revenue Code if other limitations, such as the passive activity rules, did not apply), Is conducted in anticipation of starting a trade or business, or Involves research or experimental expenditures that are deductible under Internal Revenue Code section 174 (or that would be deductible if you chose to deduct rather than capitalize them). H&r blocks A trade or business activity does not include a rental activity or the rental of property that is incidental to an activity of holding the property for investment. H&r blocks You generally report trade or business activities on Schedule C, C-EZ, F, or in Part II or III of Schedule E. H&r blocks Rental Activities A rental activity is a passive activity even if you materially participated in that activity, unless you materially participated as a real estate professional. H&r blocks See Real Estate Professional under Activities That Are Not Passive Activities, later. H&r blocks An activity is a rental activity if tangible property (real or personal) is used by customers or held for use by customers, and the gross income (or expected gross income) from the activity represents amounts paid (or to be paid) mainly for the use of the property. H&r blocks It does not matter whether the use is under a lease, a service contract, or some other arrangement. H&r blocks Exceptions. H&r blocks   Your activity is not a rental activity if any of the following apply. H&r blocks The average period of customer use of the property is 7 days or less. H&r blocks You figure the average period of customer use by dividing the total number of days in all rental periods by the number of rentals during the tax year. H&r blocks If the activity involves renting more than one class of property, multiply the average period of customer use of each class by a fraction. H&r blocks The numerator of the fraction is the gross rental income from that class of property and the denominator is the activity's total gross rental income. H&r blocks The activity's average period of customer use will equal the sum of the amounts for each class. H&r blocks The average period of customer use of the property, as figured in (1) above, is 30 days or less and you provide significant personal services with the rentals. H&r blocks Significant personal services include only services performed by individuals. H&r blocks To determine if personal services are significant, all relevant facts and circumstances are taken into consideration, including the frequency of the services, the type and amount of labor required to perform the services, and the value of the services relative to the amount charged for use of the property. H&r blocks Significant personal services do not include the following. H&r blocks Services needed to permit the lawful use of the property, Services to repair or improve property that would extend its useful life for a period substantially longer than the average rental, and Services that are similar to those commonly provided with long-term rentals of real estate, such as cleaning and maintenance of common areas or routine repairs. H&r blocks You provide extraordinary personal services in making the rental property available for customer use. H&r blocks Services are extraordinary personal services if they are performed by individuals and the customers' use of the property is incidental to their receipt of the services. H&r blocks The rental is incidental to a nonrental activity. H&r blocks The rental of property is incidental to an activity of holding property for investment if the main purpose of holding the property is to realize a gain from its appreciation and the gross rental income from the property is less than 2% of the smaller of the property's unadjusted basis or fair market value. H&r blocks The unadjusted basis of property is its cost not reduced by depreciation or any other basis adjustment. H&r blocks The rental of property is incidental to a trade or business activity if all of the following apply. H&r blocks You own an interest in the trade or business activity during the year. H&r blocks The rental property was used mainly in that trade or business activity during the current year, or during at least 2 of the 5 preceding tax years. H&r blocks Your gross rental income from the property is less than 2% of the smaller of its unadjusted basis or fair market value. H&r blocks Lodging provided to an employee or the employee's spouse or dependents is incidental to the activity or activities in which the employee performs services if the lodging is furnished for the employer's convenience. H&r blocks You customarily make the rental property available during defined business hours for nonexclusive use by various customers. H&r blocks You provide the property for use in a nonrental activity in your capacity as an owner of an interest in the partnership, S corporation, or joint venture conducting that activity. H&r blocks    If you meet any of the exceptions listed above, see the instructions for Form 8582 for information about how to report any income or loss from the activity. H&r blocks Special $25,000 allowance. H&r blocks   If you or your spouse actively participated in a passive rental real estate activity, the amount of the passive activity loss that is disallowed is decreased and you therefore can deduct up to $25,000 of loss from the activity from your nonpassive income. H&r blocks This special allowance is an exception to the general rule disallowing the passive activity loss. H&r blocks Similarly, you can offset credits from the activity against the tax on up to $25,000 of nonpassive income after taking into account any losses allowed under this exception. H&r blocks   If you are married, filing a separate return, and lived apart from your spouse for the entire tax year, your special allowance cannot be more than $12,500. H&r blocks If you lived with your spouse at any time during the year and are filing a separate return, you cannot use the special allowance to reduce your nonpassive income or tax on nonpassive income. H&r blocks   The maximum special allowance is reduced if your modified adjusted gross income exceeds certain amounts. H&r blocks See Phaseout rule , later. H&r blocks Example. H&r blocks Kate, a single taxpayer, has $70,000 in wages, $15,000 income from a limited partnership, a $26,000 loss from rental real estate activities in which she actively participated, and is not subject to the modified adjusted gross income phaseout rule. H&r blocks She can use $15,000 of her $26,000 loss to offset her $15,000 passive income from the partnership. H&r blocks She actively participated in her rental real estate activities, so she can use the remaining $11,000 rental real estate loss to offset $11,000 of her nonpassive income (wages). H&r blocks Commercial revitalization deduction (CRD). H&r blocks   The special allowance must first be applied to losses from rental real estate activities figured without the CRD. H&r blocks Any remaining part of the special allowance is available for the CRD from the rental real estate activities and is not subject to the active participation rules or the phaseout based on modified adjusted gross income. H&r blocks You cannot claim a CRD for a building placed in service after December 31, 2009. H&r blocks Active participation. H&r blocks   Active participation is not the same as material participation (defined later). H&r blocks Active participation is a less stringent standard than material participation. H&r blocks For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. H&r blocks Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions. H&r blocks   Only individuals can actively participate in rental real estate activities. H&r blocks However, a decedent's estate is treated as actively participating for its tax years ending less than 2 years after the decedent's death, if the decedent would have satisfied the active participation requirement for the activity for the tax year the decedent died. H&r blocks   A decedent's qualified revocable trust can also be treated as actively participating if both the trustee and the executor (if any) of the estate choose to treat the trust as part of the estate. H&r blocks The choice applies to tax years ending after the decedent's death and before: 2 years after the decedent's death if no estate tax return is required, or 6 months after the estate tax liability is finally determined if an estate tax return is required. H&r blocks   The choice is irrevocable and cannot be made later than the due date for the estate's first income tax return (including any extensions). H&r blocks   Limited partners are not treated as actively participating in a partnership's rental real estate activities. H&r blocks   You are not treated as actively participating in a rental real estate activity unless your interest in the activity (including your spouse's interest) was at least 10% (by value) of all interests in the activity throughout the year. H&r blocks   Active participation is not required to take the low-income housing credit, the rehabilitation investment credit, or CRD from rental real estate activities. H&r blocks Example. H&r blocks Mike, a single taxpayer, had the following income and loss during the tax year: Salary $42,300 Dividends 300 Interest 1,400 Rental loss (4,000) The rental loss came from a house Mike owned. H&r blocks He advertised and rented the house to the current tenant himself. H&r blocks He also collected the rents and did the repairs or hired someone to do them. H&r blocks Even though the rental loss is a loss from a passive activity, Mike can use the entire $4,000 loss to offset his other income because he actively participated. H&r blocks Phaseout rule. H&r blocks   The maximum special allowance of $25,000 ($12,500 for married individuals filing separate returns and living apart at all times during the year) is reduced by 50% of the amount of your modified adjusted gross income that is more than $100,000 ($50,000 if you are married filing separately). H&r blocks If your modified adjusted gross income is $150,000 or more ($75,000 or more if you are married filing separately), you generally cannot use the special allowance. H&r blocks    Modified adjusted gross income for this purpose is your adjusted gross income figured without the following. H&r blocks Taxable social security and tier 1 railroad retirement benefits. H&r blocks Deductible contributions to individual retirement accounts (IRAs) and section 501(c)(18) pension plans. H&r blocks The exclusion from income of interest from qualified U. H&r blocks S. H&r blocks savings bonds used to pay qualified higher education expenses. H&r blocks The exclusion from income of amounts received from an employer's adoption assistance program. H&r blocks Passive activity income or loss included on Form 8582. H&r blocks Any rental real estate loss allowed because you materially participated in the rental activity as a Real Estate Professional (as discussed later, under Activities That Are Not Passive Activities). H&r blocks Any overall loss from a publicly traded partnership (see Publicly Traded Partnerships (PTPs) in the instructions for Form 8582). H&r blocks The deduction for the employer-equivalent portion of self-employment tax. H&r blocks The deduction for domestic production activities. H&r blocks The deduction allowed for interest on student loans. H&r blocks The deduction for qualified tuition and related expenses. H&r blocks Example. H&r blocks During 2013, John was unmarried and was not a real estate professional. H&r blocks For 2013, he had $120,000 in salary and a $31,000 loss from his rental real estate activities in which he actively participated. H&r blocks His modified adjusted gross income is $120,000. H&r blocks When he files his 2013 return, he can deduct only $15,000 of his passive activity loss. H&r blocks He must carry over the remaining $16,000 passive activity loss to 2014. H&r blocks He figures his deduction and carryover as follows: Adjusted gross income, modified as required $120,000       Minus amount not subject to phaseout 100,000 Amount subject to phaseout rule $20,000 Multiply by 50% × 50% Required reduction to special allowance $10,000 Maximum special allowance $25,000 Minus required reduction (see above) 10,000 Adjusted special allowance $15,000 Passive loss from rental real estate $31,000 Deduction allowable/Adjusted  special allowance (see above) 15,000       Amount that must be carried forward $16,000 Exceptions to the phaseout rules. H&r blocks   A higher phaseout range applies to rehabilitation investment credits from rental real estate activities. H&r blocks For those credits, the phaseout of the $25,000 special allowance starts when your modified adjusted gross income exceeds $200,000 ($100,000 if you are a married individual filing a separate return and living apart at all times during the year). H&r blocks   There is no phaseout of the $25,000 special allowance for low-income housing credits or for the CRD. H&r blocks Ordering rules. H&r blocks   If you have more than one of the exceptions to the phaseout rules in the same tax year, you must apply the $25,000 phaseout against your passive activity losses and credits in the following order. H&r blocks The portion of passive activity losses not attributable to the CRD. H&r blocks The portion of passive activity losses attributable to the CRD. H&r blocks The portion of passive activity credits attributable to credits other than the rehabilitation and low-income housing credits. H&r blocks The portion of passive activity credits attributable to the rehabilitation credit. H&r blocks The portion of passive activity credits attributable to the low-income housing credit. H&r blocks Activities That Are Not Passive Activities The following are not passive activities. H&r blocks Trade or business activities in which you materially participated for the tax year. H&r blocks A working interest in an oil or gas well which you hold directly or through an entity that does not limit your liability (such as a general partner interest in a partnership). H&r blocks It does not matter whether you materially participated in the activity for the tax year. H&r blocks However, if your liability was limited for part of the year (for example, you converted your general partner interest to a limited partner interest during the year) and you had a net loss from the well for the year, some of your income and deductions from the working interest may be treated as passive activity gross income and passive activity deductions. H&r blocks  See Temporary Regulations section 1. H&r blocks 469-1T(e)(4)(ii). H&r blocks The rental of a dwelling unit that you also used for personal purposes during the year for more than the greater of 14 days or 10% of the number of days during the year that the home was rented at a fair rental. H&r blocks An activity of trading personal property for the account of those who own interests in the activity. H&r blocks See Temporary Regulations section 1. H&r blocks 469-1T(e)(6). H&r blocks Rental real estate activities in which you materially participated as a real estate professional. H&r blocks See Real Estate Professional , later. H&r blocks You should not enter income and losses from these activities on Form 8582. H&r blocks Instead, enter them on the forms or schedules you would normally use. H&r blocks Material Participation A trade or business activity is not a passive activity if you materially participated in the activity. H&r blocks Material participation tests. H&r blocks    You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests. H&r blocks You participated in the activity for more than 500 hours. H&r blocks Your participation was substantially all the participation in the activity of all individuals for the tax year, including the participation of individuals who did not own any interest in the activity. H&r blocks You participated in the activity for more than 100 hours during the tax year, and you participated at least as much as any other individual (including individuals who did not own any interest in the activity) for the year. H&r blocks The activity is a significant participation activity, and you participated in all significant participation activities for more than 500 hours. H&r blocks A significant participation activity is any trade or business activity in which you participated for more than 100 hours during the year and in which you did not materially participate under any of the material participation tests, other than this test. H&r blocks See Significant Participation Passive Activities , under Recharacterization of Passive Income, later. H&r blocks You materially participated in the activity for any 5 (whether or not consecutive) of the 10 immediately preceding tax years. H&r blocks The activity is a personal service activity in which you materially participated for any 3 (whether or not consecutive) preceding tax years. H&r blocks An activity is a personal service activity if it involves the performance of personal services in the fields of health (including veterinary services), law, engineering, architecture, accounting, actuarial science, performing arts, consulting, or any other trade or business in which capital is not a material income-producing factor. H&r blocks Based on all the facts and circumstances, you participated in the activity on a regular, continuous, and substantial basis during the year. H&r blocks   You did not materially participate in the activity under test (7) if you participated in the activity for 100 hours or less during the year. H&r blocks Your participation in managing the activity does not count in determining whether you materially participated under this test if: Any person other than you received compensation for managing the activity, or Any individual spent more hours during the tax year managing the activity than you did (regardless of whether the individual was compensated for the management services). H&r blocks Participation. H&r blocks   In general, any work you do in connection with an activity in which you own an interest is treated as participation in the activity. H&r blocks Work not usually performed by owners. H&r blocks   You do not treat the work you do in connection with an activity as participation in the activity if both of the following are true. H&r blocks The work is not work that is customarily done by the owner of that type of activity. H&r blocks One of your main reasons for doing the work is to avoid the disallowance of any loss or credit from the activity under the passive activity rules. H&r blocks Participation as an investor. H&r blocks   You do not treat the work you do in your capacity as an investor in an activity as participation unless you are directly involved in the day-to-day management or operations of the activity. H&r blocks Work you do as an investor includes: Studying and reviewing financial statements or reports on operations of the activity, Preparing or compiling summaries or analyses of the finances or operations of the activity for your own use, and Monitoring the finances or operations of the activity in a nonmanagerial capacity. H&r blocks Spouse's participation. H&r blocks   Your participation in an activity includes your spouse's participation. H&r blocks This applies even if your spouse did not own any interest in the activity and you and your spouse do not file a joint return for the year. H&r blocks Proof of participation. H&r blocks You can use any reasonable method to prove your participation in an activity for the year. H&r blocks You do not have to keep contemporaneous daily time reports, logs, or similar documents if you can establish your participation in some other way. H&r blocks For example, you can show the services you performed and the approximate number of hours spent by using an appointment book, calendar, or narrative summary. H&r blocks Limited partners. H&r blocks   If you owned an activity as a limited partner, you generally are not treated as materially participating in the activity. H&r blocks However, you are treated as materially participating in the activity if you met test (1), (5), or (6) under Material participation tests , discussed earlier, for the tax year. H&r blocks   You are not treated as a limited partner, however, if you also were a general partner in the partnership at all times during the partnership's tax year ending with or within your tax year (or, if shorter, during that part of the partnership's tax year in which you directly or indirectly owned your limited partner interest). H&r blocks Retired or disabled farmer and surviving spouse of a farmer. H&r blocks   If you are a retired or disabled farmer, you are treated as materially participating in a farming activity if you materially participated for 5 or more of the 8 years before your retirement or disability. H&r blocks Similarly, if you are a surviving spouse of a farmer, you are treated as materially participating in a farming activity if the real property used in the activity meets the estate tax rules for special valuation of farm property passed from a qualifying decedent, and you actively manage the farm. H&r blocks Corporations. H&r blocks   A closely held corporation or a personal service corporation is treated as materially participating in an activity only if one or more shareholders holding more than 50% by value of the outstanding stock of the corporation materially participate in the activity. H&r blocks   A closely held corporation can also satisfy the material participation standard by meeting the first two requirements for the qualifying business exception from the at-risk limits. H&r blocks See Special exception for qualified corporations under Activities Covered by the At-Risk Rules, later. H&r blocks Real Estate Professional Generally, rental activities are passive activities even if you materially participated in them. H&r blocks However, if you qualified as a real estate professional, rental real estate activities in which you materially participated are not passive activities. H&r blocks For this purpose, each interest you have in a rental real estate activity is a separate activity, unless you choose to treat all interests in rental real estate activities as one activity. H&r blocks See the Instructions for Schedule E (Form 1040), Supplemental Income and Loss, for information about making this choice. H&r blocks If you qualified as a real estate professional for 2013, report income or losses from rental real estate activities in which you materially participated as nonpassive income or losses, and complete line 43 of Schedule E (Form 1040). H&r blocks If you also have an unallowed loss from these activities from an earlier year when you did not qualify, see Treatment of former passive activities under Passive Activities, earlier. H&r blocks Qualifications. H&r blocks   You qualified as a real estate professional for the year if you met both of the following requirements. H&r blocks More than half of the personal services you performed in all trades or businesses during the tax year were performed in real property trades or businesses in which you materially participated. H&r blocks You performed more than 750 hours of services during the tax year in real property trades or businesses in which you materially participated. H&r blocks   Do not count personal services you performed as an employee in real property trades or businesses unless you were a 5% owner of your employer. H&r blocks You were a 5% owner if you owned (or are considered to have owned) more than 5% of your employer's outstanding stock, outstanding voting stock, or capital or profits interest. H&r blocks   If you file a joint return, do not count your spouse's personal services to determine whether you met the preceding requirements. H&r blocks However, you can count your spouse's participation in an activity in determining if you materially participated. H&r blocks Real property trades or businesses. H&r blocks   A real property trade or business is a trade or business that does any of the following with real property. H&r blocks Develops or redevelops it. H&r blocks Constructs or reconstructs it. H&r blocks Acquires it. H&r blocks Converts it. H&r blocks Rents or leases it. H&r blocks Operates or manages it. H&r blocks Brokers it. H&r blocks Closely held corporations. H&r blocks   A closely held corporation can qualify as a real estate professional if more than 50% of the gross receipts for its tax year came from real property trades or businesses in which it materially participated. H&r blocks Passive Activity Income and Deductions In figuring your net income or loss from a passive activity, take into account only passive activity income and passive activity deductions. H&r blocks Self-charged interest. H&r blocks   Certain self-charged interest income or deductions may be treated as passive activity gross income or passive activity deductions if the loan proceeds are used in a passive activity. H&r blocks   Generally, self-charged interest income and deductions result from loans between you and a partnership or S corporation in which you had a direct or indirect ownership interest. H&r blocks This includes both loans you made to the partnership or S corporation and loans the partnership or S corporation made to you. H&r blocks   It also includes loans from one partnership or S corporation to another partnership or S corporation if each owner in the borrowing entity has the same proportional ownership interest in the lending entity. H&r blocks    Exception. H&r blocks The self-charged interest rules do not apply to your interest in a partnership or S corporation if the entity made an election under Regulations section 1. H&r blocks 469-7(g) to avoid the application of these rules. H&r blocks For more details on the self-charged interest rules, see Regulations section 1. H&r blocks 469-7. H&r blocks Passive Activity Income Passive activity income includes all income from passive activities and generally includes gain from disposition of an interest in a passive activity or property used in a passive activity. H&r blocks Passive activity income does not include the following items. H&r blocks Income from an activity that is not a passive activity. H&r blocks These activities are discussed under Activities That Are Not Passive Activities , earlier. H&r blocks Portfolio income. H&r blocks This includes interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business. H&r blocks It includes gain or loss from the disposition of property that produces these types of income or that is held for investment. H&r blocks The exclusion for portfolio income does not apply to self-charged interest treated as passive activity income. H&r blocks For more information on self-charged interest, see Self-charged interest , earlier. H&r blocks Personal service income. H&r blocks This includes salaries, wages, commissions, self-employment income from trade or business activities in which you materially participated, deferred compensation, taxable social security and other retirement benefits, and payments from partnerships to partners for personal services. H&r blocks Income from positive section 481 adjustments allocated to activities other than passive activities. H&r blocks (Section 481 adjustments are adjustments that must be made due to changes in your accounting method. H&r blocks ) Income or gain from investments of working capital. H&r blocks Income from an oil or gas property if you treated any loss from a working interest in the property for any tax year beginning after 1986 as a nonpassive loss, as discussed in item (2) under Activities That Are Not Passive Activities , earlier. H&r blocks This also applies to income from other oil and gas property the basis of which is determined wholly or partly by the basis of the property in the preceding sentence. H&r blocks Any income from intangible property, such as a patent, copyright, or literary, musical, or artistic composition, if your personal efforts significantly contributed to the creation of the property. H&r blocks Any other income that must be treated as nonpassive income. H&r blocks See Recharacterization of Passive Income , later. H&r blocks Overall gain from any interest in a publicly traded partnership. H&r blocks See Publicly Traded Partnerships (PTPs) in the instructions for Form 8582. H&r blocks State, local, and foreign income tax refunds. H&r blocks Income from a covenant not to compete. H&r blocks Reimbursement of a casualty or theft loss included in gross income to recover all or part of a prior year loss deduction, if the loss deduction was not a passive activity deduction. H&r blocks Alaska Permanent Fund dividends. H&r blocks Cancellation of debt income, if at the time the debt is discharged the debt is not allocated to passive activities under the interest expense allocation rules. H&r blocks See chapter 4 of Publication 535, Business Expenses, for information about the rules for allocating interest. H&r blocks Disposition of property interests. H&r blocks   Gain on the disposition of an interest in property generally is passive activity income if, at the time of the disposition, the property was used in an activity that was a passive activity in the year of disposition. H&r blocks The gain generally is not passive activity income if, at the time of disposition, the property was used in an activity that was not a passive activity in the year of disposition. H&r blocks An exception to this general rule may apply if you previously used the property in a different activity. H&r blocks Exception for more than one use in the preceding 12 months. H&r blocks   If you used the property in more than one activity during the 12-month period before its disposition, you must allocate the gain between the activities on a basis that reasonably reflects the property's use during that period. H&r blocks Any gain allocated to a passive activity is passive activity income. H&r blocks   For this purpose, an allocation of the gain solely to the activity in which the property was mainly used during that period reasonably reflects the property's use if the fair market value of your interest in the property is not more than the lesser of: $10,000, or 10% of the total of the fair market value of your interest in the property and the fair market value of all other property used in that activity immediately before the disposition. H&r blocks Exception for substantially appreciated property. H&r blocks   The gain is passive activity income if the fair market value of the property at disposition was more than 120% of its adjusted basis and either of the following conditions applies. H&r blocks You used the property in a passive activity for 20% of the time you held your interest in the property. H&r blocks You used the property in a passive activity for the entire 24-month period before its disposition. H&r blocks If neither condition applies, the gain is not passive activity income. H&r blocks However, it is treated as portfolio income only if you held the property for investment for more than half of the time you held it in nonpassive activities. H&r blocks   For this purpose, treat property you held through a corporation (other than an S corporation) or other entity whose owners receive only portfolio income as property held in a nonpassive activity and as property held for investment. H&r blocks Also, treat the date you agree to transfer your interest for a fixed or determinable amount as the disposition date. H&r blocks   If you used the property in more than one activity during the 12-month period before its disposition, this exception applies only to the part of the gain allocated to a passive activity under the rules described in the preceding discussion. H&r blocks Disposition of property converted to inventory. H&r blocks   If you disposed of property that you had converted to inventory from its use in another activity (for example, you sold condominium units you previously held for use in a rental activity), a special rule may apply. H&r blocks Under this rule, you disregard the property's use as inventory and treat it as if it were still used in that other activity at the time of disposition. H&r blocks This rule applies only if you meet all of the following conditions. H&r blocks At the time of disposition, you held your interest in the property in a dealing activity (an activity that involves holding the property or similar property mainly for sale to customers in the ordinary course of a trade or business). H&r blocks Your other activities included a nondealing activity (an activity that does not involve holding similar property for sale to customers in the ordinary course of a trade or business) in which you used the property for more than 80% of the period you held it. H&r blocks You did not acquire or hold your interest in the property for the main purpose of selling it to customers in the ordinary course of a trade or business. H&r blocks Passive Activity Deductions Generally, a deduction is a passive activity deduction for a taxable year if and only if such deduction either: Arises in connection with the conduct of an activity that is a passive activity for the tax year; or Is treated as a deduction from an activity for the tax year because it was disallowed by the passive activity rules in the preceding year and carried forward to the tax year. H&r blocks For purposes of item (1), above, an item of deduction arises in the taxable year in which the item would be allowable as a deduction under the taxpayer's method of accounting if taxable income for all taxable years were determined without regard to the passive activity rules and without regard to the basis, excess farm loss, and at-risk limits. H&r blocks See Coordination with other limitations on deductions that apply before the passive activity rules , later. H&r blocks Passive activity deductions generally include losses from dispositions of property used in a passive activity at the time of the disposition and losses from a disposition of less than your entire interest in a passive activity. H&r blocks Exceptions. H&r blocks   Passive activity deductions do not include the following items. H&r blocks Deductions for expenses (other than interest expense) that are clearly and directly allocable to portfolio income. H&r blocks Qualified home mortgage interest, capitalized interest expenses, and other interest expenses (other than self-charged interest) properly allocable to passive activities. H&r blocks For more information on self-charged interest, see Self-charged interest under Passive Activity Income and Deductions, earlier. H&r blocks Losses from dispositions of property that produce portfolio income or property held for investment. H&r blocks State, local, and foreign income taxes. H&r blocks Miscellaneous itemized deductions that may be disallowed because of the 2%-of-adjusted-gross-income limit. H&r blocks Charitable contribution deductions. H&r blocks Net operating loss deductions. H&r blocks Percentage depletion carryovers for oil and gas wells. H&r blocks Capital loss carrybacks and carryovers. H&r blocks Items of deduction from a passive activity that are disallowed under the limits on deductions that apply before the passive activity rules. H&r blocks See Coordination with other limitations on deductions that apply before the passive activity rules , later. H&r blocks Deductions and losses that would have been allowed for tax years beginning before 1987 but for basis or at-risk limits. H&r blocks Net negative section 481 adjustments allocated to activities other than passive activities. H&r blocks (Section 481 adjustments are adjustments required due to changes in accounting methods. H&r blocks ) Casualty and theft losses, unless losses similar in cause and severity recur regularly in the activity. H&r blocks The deduction for the employer-equivalent portion of self-employment tax. H&r blocks Coordination with other limitations on deductions that apply before the passive activity rules. H&r blocks   An item of deduction from a passive activity that is disallowed for a tax year under the basis or at-risk limitations is not a passive activity deduction for the tax year. H&r blocks The following sections provide rules for figuring the extent to which items of deduction from a passive activity are disallowed for a tax year under the basis or at-risk limitations. H&r blocks Proration of deductions disallowed under basis limitations. H&r blocks   If any amount of your distributive share of a partnership's loss for the tax year is disallowed under the basis limitation, a ratable portion of your distributive share of each item of deduction or loss of the partnership is disallowed for the tax year. H&r blocks For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of your distributive share of partnership loss that is disallowed for the taxable year; by The sum of your distributive shares of all items of deduction and loss of the partnership for the tax year. H&r blocks   If any amount of your pro rata share of an S corporation's loss for the tax year is disallowed under the basis limitation, a ratable portion of your pro rata share of each item of deduction or loss of the S corporation is disallowed for the tax year. H&r blocks For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of your share of S corporation loss that is disallowed for the tax year; by The sum of your pro rata shares of all items of deduction and loss of the corporation for the tax year. H&r blocks Proration of deductions disallowed under at-risk limitation. H&r blocks   If any amount of your loss from an activity (as defined in Activities Covered by the At-Risk Rules , later) is disallowed under the at-risk rules for the tax year, a ratable portion of each item of deduction or loss from the activity is disallowed for the tax year. H&r blocks For this purpose, the ratable portion of an item of deduction or loss is the amount of such item multiplied by the fraction obtained by dividing: The amount of the loss from the activity that is disallowed for the tax year; by The sum of all deductions from the activity for the taxable year. H&r blocks Coordination of basis and at-risk limitations. H&r blocks   The portion of any item of deduction or loss that is disallowed for the tax year under the basis limitations is not taken into account for the taxable year in determining the loss from an activity (as defined in Activities Covered by the At-Risk Rules , later) for purposes of applying the at-risk rules. H&r blocks Separately identified items of deduction and loss. H&r blocks   In identifying the items of deduction and loss from an activity that are not disallowed under the basis and at-risk limitations (and that therefore may be treated as passive activity deductions), you need not account separately for any item of deduction or loss unless such item may, if separately taken into account, result in an income tax liability different from that which would result were such item of deduction or loss taken into account separately. H&r blocks   Items of deduction or loss that must be accounted for separately include (but are not limited to) items of deduction or loss that: Are attributable to separate activities. H&r blocks See Grouping Your Activities , later. H&r blocks Arise in a rental real estate activity in tax years in which you actively participate in such activity; Arise in a rental real estate activity in taxable years in which you do not actively participate in such activity; Arose in a taxable year beginning before 1987 and were not allowed for such taxable year under the basis or at-risk limitations; Are taken into account under section 613A(d) (relating to limitations on certain depletion deductions); Are taken into account under section 1211 (relating to the limitation on capital losses); Are taken into account under section 1231 (relating to property used in a trade or business and involuntary conversions). H&r blocks See Section 1231 Gains and Losses in Publication 544 for more information. H&r blocks Are attributable to pre-enactment interests in activities. H&r blocks See Regulations section 1. H&r blocks 469-11T(c). H&r blocks Grouping Your Activities You can treat one or more trade or business activities, or rental activities, as a single activity if those activities form an appropriate economic unit for measuring gain or loss under the passive activity rules. H&r blocks Grouping is important for a number of reasons. H&r blocks If you group two activities into one larger activity, you need only show material participation in the activity as a whole. H&r blocks But if the two activities are separate, you must show material participation in each one. H&r blocks On the other hand, if you group two activities into one larger activity and you dispose of one of the two, then you have disposed of only part of your entire interest in the activity. H&r blocks But if the two activities are separate and you dispose of one of them, then you have disposed of your entire interest in that activity. H&r blocks Grouping can also be important in determining whether you meet the 10% ownership requirement for actively participating in a rental real estate activity. H&r blocks Appropriate Economic Units Generally, to determine if activities form an appropriate economic unit, you must consider all the relevant facts and circumstances. H&r blocks You can use any reasonable method of applying the relevant facts and circumstances in grouping activities. H&r blocks The following factors have the greatest weight in determining whether activities form an appropriate economic unit. H&r blocks All of the factors do not have to apply to treat more than one activity as a single activity. H&r blocks The factors that you should consider are: The similarities and differences in the types of trades or businesses, The extent of common control, The extent of common ownership, The geographical location, and The interdependencies between or among activities, which may include the extent to which the activities: Buy or sell goods between or among themselves, Involve products or services that are generally provided together, Have the same customers, Have the same employees, or Use a single set of books and records to account for the activities. H&r blocks Example 1. H&r blocks John Jackson owns a bakery and a movie theater at a shopping mall in Baltimore and a bakery and movie theater in Philadelphia. H&r blocks Based on all the relevant facts and circumstances, there may be more than one reasonable method for grouping John's activities. H&r blocks For example, John may be able to group the movie theaters and the bakeries into: One activity, A movie theater activity and a bakery activity, A Baltimore activity and a Philadelphia activity, or Four separate activities. H&r blocks Example 2. H&r blocks Betty is a partner in ABC partnership, which sells nonfood items to grocery stores. H&r blocks Betty is also a partner in DEF (a trucking business). H&r blocks ABC and DEF are under common control. H&r blocks The main part of DEF's business is transporting goods for ABC. H&r blocks DEF is the only trucking business in which Betty is involved. H&r blocks Based on the rules of this section, Betty treats ABC's wholesale activity and DEF's trucking activity as a single activity. H&r blocks Consistency and disclosure requirement. H&r blocks   Generally, when you group activities into appropriate economic units, you may not regroup those activities in a later tax year. H&r blocks You must meet any disclosure requirements of the IRS when you first group your activities and when you add or dispose of any activities in your groupings. H&r blocks   However, if the original grouping is clearly inappropriate or there is a material change in the facts and circumstances that makes the original grouping clearly inappropriate, you must regroup the activities and comply with any disclosure requirements of the IRS. H&r blocks   See Disclosure Requirement , later. H&r blocks Regrouping by the IRS. H&r blocks   If any of the activities resulting from your grouping is not an appropriate economic unit and one of the primary purposes of your grouping (or failure to regroup) is to avoid the passive activity rules, the IRS may regroup your activities. H&r blocks Rental activities. H&r blocks   In general, you cannot group a rental activity with a trade or business activity. H&r blocks However, you can group them together if the activities form an appropriate economic unit and: The rental activity is insubstantial in relation to the trade or business activity, The trade or business activity is insubstantial in relation to the rental activity, or Each owner of the trade or business activity has the same ownership interest in the rental activity, in which case the part of the rental activity that involves the rental of items of property for use in the trade or business activity may be grouped with the trade or business activity. H&r blocks Example. H&r blocks Herbert and Wilma are married and file a joint return. H&r blocks Healthy Food, an S corporation, is a grocery store business. H&r blocks Herbert is Healthy Food's only shareholder. H&r blocks Plum Tower, an S corporation, owns and rents out the building. H&r blocks Wilma is Plum Tower's only shareholder. H&r blocks Plum Tower rents part of its building to Healthy Food. H&r blocks Plum Tower's grocery store rental business and Healthy Food's grocery business are not insubstantial in relation to each other. H&r blocks Herbert and Wilma file a joint return, so they are treated as one taxpayer for purposes of the passive activity rules. H&r blocks The same owner (Herbert and Wilma) owns both Healthy Food and Plum Tower with the same ownership interest (100% in each). H&r blocks If the grouping forms an appropriate economic unit, as discussed earlier, Herbert and Wilma can group Plum Tower's grocery store rental and Healthy Food's grocery business into a single trade or business activity. H&r blocks Grouping of real and personal property rentals. H&r blocks   In general, you cannot treat an activity involving the rental of real property and an activity involving the rental of personal property as a single activity. H&r blocks However, you can treat them as a single activity if you provide the personal property in connection with the real property or the real property in connection with the personal property. H&r blocks Certain activities may not be grouped. H&r blocks   In general, if you own an interest as a limited partner or a limited entrepreneur in one of the following activities, you may not group that activity with any other activity in another type of business. H&r blocks Holding, producing, or distributing motion picture films or video tapes. H&r blocks Farming. H&r blocks Leasing any section 1245 property (as defined in section 1245(a)(3) of the Internal Revenue Code). H&r blocks For a list of section 1245 property, see Section 1245 property under Activities Covered by the At-Risk Rules , later. H&r blocks Exploring for, or exploiting, oil and gas resources. H&r blocks Exploring for, or exploiting, geothermal deposits. H&r blocks   If you own an interest as a limited partner or a limited entrepreneur in an activity described in the list above, you may group that activity with another activity in the same type of business if the grouping forms an appropriate economic unit as discussed earlier. H&r blocks Limited entrepreneur. H&r blocks   A limited entrepreneur is a person who: Has an interest in an enterprise other than as a limited partner, and Does not actively participate in the management of the enterprise. H&r blocks Activities conducted through another entity. H&r blocks   A personal service corporation, closely held corporation, partnership, or S corporation must group its activities using the rules discussed in this section. H&r blocks Once the entity groups its activities, you, as the partner or shareholder of the entity, may group those activities (following the rules of this section): With each other, With activities conducted directly by you, or With activities conducted through other entities. H&r blocks    You may not treat activities grouped together by the entity as separate activities. H&r blocks Personal service and closely held corporations. H&r blocks   You may group an activity conducted through a personal service or closely held corporation with your other activities only to determine whether you materially or significantly participated in those other activities. H&r blocks See Material Participation , earlier, and Significant Participation Passive Activities , later. H&r blocks Publicly traded partnership (PTP). H&r blocks   You may not group activities conducted through a PTP with any other activity, including an activity conducted through another PTP. H&r blocks Partial dispositions. H&r blocks   If you dispose of substantially all of an activity during your tax year, you may treat the part disposed of as a separate activity. H&r blocks However, you can do this only if you can show with reasonable certainty: The amount of deductions and credits disallowed in prior years under the passive activity rules that is allocable to the part of the activity disposed of, and The amount of gross income and any other deductions and credits for the current tax year that is allocable to the part of the activity disposed of. H&r blocks Disclosure Requirement For tax years beginning after January 24, 2010, the following disclosure requirements for groupings apply. H&r blocks You are required to report certain changes to your groupings that occur during the tax year to the IRS. H&r blocks If you fail to report these changes, each trade or business activity or rental activity will be treated as a separate activity. H&r blocks You will be considered to have made a timely disclosure if you filed all affected income tax returns consistent with the claimed grouping and make the required disclosure on the income tax return for the year in which you first discovered the failure to disclose. H&r blocks If the IRS discovered the failure to disclose, you must have reasonable cause for not making the required disclosure. H&r blocks New grouping. H&r blocks   You must file a written statement with your original income tax return for the first tax year in which two or more activities are originally grouped into a single activity. H&r blocks The statement must provide the names, addresses, and employer identification numbers (EINs), if applicable, for the activities being grouped as a single activity. H&r blocks In addition, the statement must contain a declaration that the grouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. H&r blocks Addition to an existing grouping. H&r blocks   You must file a written statement with your original income tax return for the tax year in which you add a new activity to an existing group. H&r blocks The statement must provide the name, address, and EIN, if applicable, for the activity that is being added and for the activities in the existing group. H&r blocks In addition, the statement must contain a declaration that the activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. H&r blocks Regrouping. H&r blocks   You must file a written statement with your original income tax return for the tax year in which you regroup the activities. H&r blocks The statement must provide the names, addresses, and EINs, if applicable, for the activities that are being regrouped. H&r blocks If two or more activities are being regrouped into a single activity, the statement must contain a declaration that the regrouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules. H&r blocks In addition, the statement must contain an explanation of the material change in the facts and circumstances that made the original grouping clearly inappropriate. H&r blocks Groupings by partnerships and S corporations. H&r blocks   Partnerships and S corporations are not subject to the rules for new grouping, addition to an existing grouping, or regrouping. H&r blocks Instead, they must comply with the disclosure instructions for grouping activities provided in their Form 1065, U. H&r blocks S. H&r blocks Return of Partnership Income, or Form 1120S, U. H&r blocks S. H&r blocks Income Tax Return for an S Corporation, whichever is applicable. H&r blocks   The partner or shareholder is not required to make a separate disclosure of the groupings disclosed by the entity unless the partner or shareholder: Groups together any of the activities that the entity does not group together, Groups the entity's activities with activities conducted directly by the partner or shareholder, or Groups an entity's activities with activities conducted through another entity. H&r blocks   A partner or shareholder may not treat activities grouped together by the entity as separate activities. H&r blocks Recharacterization of Passive Income Net income from the following passive activities may have to be recharacterized and excluded from passive activity income. H&r blocks Significant participation passive activities, Rental of property when less than 30% of the unadjusted basis of the property is subject to depreciation, Equity-financed lending activities, Rental of property incidental to development activities, Rental of property to nonpassive activities, and Licensing of intangible property by  pass-through entities. H&r blocks If you are engaged in or have an interest in one of these activities during the tax year (either directly or through a partnership or an S corporation), combine the income and losses from the activity to determine if you have a net loss or net income from that activity. H&r blocks If the result is a net loss, treat the income and losses the same as any other income or losses from that type of passive activity (trade or business activity or rental activity). H&r blocks If the result is net income, do not enter any of the income or losses from the activity or property on Form 8582 or its worksheets. H&r blocks Instead, enter income or losses on the form and schedules you normally use. H&r blocks However, see Significant Participation Passive Activities , later, if the activity is a significant participation passive activity and you also have a net loss from a different significant participation passive activity. H&r blocks Limit on recharacterized passive income. H&r blocks   The total amount that you treat as nonpassive income under the rules described later in this discussion for significant participation passive activities, rental of nondepreciable property, and equity-financed lending activities cannot exceed the greatest amount that you treat as nonpassive income under any one of these rules. H&r blocks Investment income and investment expense. H&r blocks   To figure your investment interest expense limitation on Form 4952, treat as investment income any net passive income recharacterized as nonpassive income from rental of nondepreciable property, equity-financed lending activity, or licensing of intangible property by a pass-through entity. H&r blocks Significant Participation Passive Activities A significant participation passive activity is any trade or business activity in which you participated for more than 100 hours during the tax year but did not materially participate. H&r blocks If your gross income from all significant participation passive activities is more than your deductions from those activities, a part of your net income from each significant participation passive activity is treated as nonpassive income. H&r blocks Corporations. H&r blocks   An activity of a personal service corporation or closely held corporation is a significant participation passive activity if both of the following statements are true. H&r blocks The corporation is not treated as materially participating in the activity for the year. H&r blocks One or more individuals, each of whom is treated as significantly participating in the activity, directly or indirectly hold (in total) more than 50% (by value) of the corporation's outstanding stock. H&r blocks Worksheet A. H&r blocks   Complete Worksheet A. H&r blocks Significant Participation Passive Activities , below, if you have income or losses from any significant participation activity. H&r blocks Begin by entering the name of each activity in the left column. H&r blocks Column (a). H&r blocks   Enter the number of hours you participated in each activity and total the column. H&r blocks   If the total is more than 500, do not complete Worksheet A or B. H&r blocks None of the activities are passive activities because you satisfy test 4 for material participation. H&r blocks (See Material participation tests , earlier. H&r blocks ) Report all the income and losses from these activities on the forms and schedules you normally use. H&r blocks Do not include the income and losses on Form 8582. H&r blocks Column (b). H&r blocks   Enter the net loss, if any, from the activity. H&r blocks Net loss from an activity means either: The activity's current year net loss (if any) plus prior year unallowed losses (if any), or The excess of prior year unallowed losses over the current year net income (if any). H&r blocks Enter -0- here if the prior year unallowed loss is the same as the current year net income. H&r blocks Column (c). H&r blocks   Enter net income (if any) from the activity. H&r blocks Net income means the excess of the current year's net income from the activity over any prior year unallowed losses from the activity. H&r blocks Column (d). H&r blocks   Combine amounts in the Totals row for columns (b) and (c) and enter the total net income or net loss in the Totals row of column (d). H&r blocks If column (d) is a net loss, skip Worksheet B, Significant Participation Activities With Net Income. H&r blocks Include the income and losses in Worksheet 3 of Form 8582 (or Worksheet 2 in the Form 88