2009 CCH. All Rights Reserved.
Deductions: Business/Investment Losses and
Passive Activity Losses
SUMMARY OF CHAPTER
Deductions are allowed for losses from unpro
table investment-related activities, dispositions of certain
assets, and unpro
table business operations. Generally, deductible losses from a business, property held for
production of income, or investment property are deductible for adjusted gross income. Losses derived from
personal-use property, if deductible, are usually deductible from adjusted gross income as an itemized deduction.
This chapter deals with losses originating from business operations and certain investment-related activities.
Tax Shelters and At-Risk Rules
¶7001 Tax Shelters
A tax shelter is an activity providing deductions and/or credits to an investor which will reduce tax liability
with respect to income from other sources. Investments in tax shelters have been restricted by the at-risk rules and
the passive activity rules. Essentially all limited partnership investments, rental properties, and businesses in which
an owner does not materially participate have been affected.
¶7125 At-Risk Rules
The at-risk rules disallow losses that are in excess of an investor’s amount at risk. In a general sense, at
risk is the amount of investment that an investor could possibly lose. An investor is not at risk for nonrecourse
borrowings, stop-loss arrangements, no-loss guarantees, or borrowings in which the lender has an interest (as in
Passive Activity Loss Rules
¶7201 Application of Rules
The at-risk rules must
rst be satis
ed, then the passive activity loss rules apply. A passive loss can then be
used in the following ways: offset passive income, offset other income (under certain conditions), and/or become
suspended. Passive income and losses are “before AGI” items.
cation of Income
Because of the passive activity rules, income is required to be classi
ed as active, passive, or portfolio
income. Ordinarily, active income is attributable to the direct efforts of the taxpayer, such as salary, commissions,
wages, etc. Passive income is income derived from a passive activity. Portfolio income is interest, dividends,
annuities, and royalties not derived in the ordinary course of a trade or business.
¶7211 Disallowance of Passive Losses and Credits
For tax years beginning in 1991, no passive activity losses or credits may be deducted against active and
portfolio income. Interests in passive activities acquired by the taxpayer on or before October 22, 1986 (the date on
which the Tax Reform Act of 1986 was enacted), were eligible for a special deduction and credit phaseout of losses
¶7215 Suspended Losses