Beware of Passive Activity Losses on Side Businesses

Section 469 of the Internal Revenue Code is a minefield for taxpayers with business or investment endeavors. The “passive activity” rules can turn seemingly deductible business losses into non-deductible losses. And, the rules for determining whether an activity is passive or not can be cumbersome.

Joe Kristan at the Tax Update Blog tells the story of a Minnesota man who owned a ranch in Colorado in addition to a successful manufacturing business. The IRS and Tax Court both disallowed losses sustained in the ranch because it was a passive activity. As Joe explains:

The regulations say you achieve “material participation” in non-real estate activities for a tax year if:

-You participate at least 500 hours; or
-You participate at least 100 hours and at least 500 hours in that and other “100 hour” activities; or
-You participate at least 100 hours and more than anybody else, or
-You are the only participant; or
-You materially participated in five of the past ten years )or in any three years for a service activity).

There is also a “facts and circumstances” test, but don’t count on it.