This is part 1 of 5 in a series on Passive Activities.

Many things can be classified as rental activities. You rent a car; you book a hotel room; you lease an office machine; you pay for a parking space. All of these fall under the broad category of being rental activities. However, there is a more limited definition of a rental activity for passive loss purposes. If a rental activity is not considered passive, it is treated as a business.

Certain rental activities are classified by regulation as businesses, and therefore, not passive activities. These include activities in which:

• The average period of customer use is seven days or less. This would include parking spaces and vacation home rentals, for example.
• The average period of customer use is 30 days or less and significant personal services are provided. Maid and linen services at a hotel are examples of significant personal services.
• Extraordinary personal services are provided. A hospital or nursing home facility would be examples falling within this category.
• Rental of such property is incidental to a non-rental activity of the taxpayer. This exception applies to property rented to employees at the employer’s convenience and investment property primarily held for appreciation. In the latter case, gross rental income from the property must be less than two percent of the lower of the property’s unadjusted basis or fair market value.
• The taxpayer makes the property available on a non-exclusive use by multiple customers during defined business hours. A golf course would meet this exception.
• Provision of the property for use in an activity conducted by a partnership, S corporation, or joint venture when the taxpayer owns an interest.

If an activity does not meet one of the above exceptions, it will be a passive activity. However, there are two exceptions that may allow the taxpayer to deduct at least some losses from the activity. The first exception applies to taxpayers whose modified adjusted gross income (AGI) is under $100,000. In this case, the taxpayer may deduct passive losses up to $25,000. This deduction is reduced by $1 for every $2 of AGI above $100,000; thus it phases out completely when AGI reaches $150,000.

The second exception allows real estate professionals to treat rental activities as a business and deduct these losses without regard to AGI. What qualifies as a real estate professional will be discussed in a future article.

It should be noted that any suspended passive losses will carry forward and may be used in the future against passive gains. Additionally the loss may be deducted when the property is disposed of in a fully taxable sale.

All rental activities, then are not subject to the passive loss rules. Even if the activity qualifies as a passive loss, the taxpayer may still be able to take a deduction under certain circumstances.