What is IRS Passive Income?

Two sources of income fall into the “passive” category. The first is income received from rental activities and the second is income originating from a business in which you have ownership but do not “materially” participate. Regardless of whether income is deemed to be passive or non-passive, it must always be reported somewhere on the return, most typically on Schedule E.  The Form 8582 is computational only, figuring the amount of passive loss deductible for the current year.  It not the form used to report income.

 

Passive Income IRS Definition

Passive income can only be generated by a passive activity.  Just because the taxpayer did not work for the income does not mean it is passive.  There are only two sources for passive income:

  1. A rental activity; or,
  2. A business in which the taxpayer does not materially participate.

Gain on a partial or entire disposition of a passive activity generally is passive income.

 

What is not Passive Income?

While the following may seem passive, generally none are passive income:

  • Portfolio income, including interest, dividends, royalties, annuities and gains on stocks and bonds;
  • Lottery winnings;
  • Salaries, wages, Form 1099-Misc. commissions and retirement income;
  • Guaranteed payments for services; and,
  • Income from any activity in which the taxpayer materially participates.

 

Reporting Passive Income on Tax Return

Certain types of income are treated (“recharacterized”) as non-passive.  If a taxpayer rents a property to a business in which he materially participates, net rental income is non-passive and should not be on Form 8582 line 1a as passive income.  See Reg. § 1.469-2(f)(6) and self-rented property checksheet at the end of the chapter.  Net rental losses, however, generally remain passive.