LET’S CLEAR UP A DEFINITION!!!

The other day I had a phone call with a prospective client. In our discussion, he used the words “passive income”. Having been a practicing Certified Public Accountant for over 50 years there is a very specific definition of the term “passive income” under the Internal Revenue Code and it’s different than what the layman uses in everyday conversation. So, I asked him what he meant by the term “passive income”. His response was what I figured it would be. According to him, a non-CPA, passive income was income that he received every month without having to do much if anything. It’s the distribution of an LLC, a REIT (Real Estate Investment Trust), a general partnership that is not a “Guaranteed Payment to Partner”.

Under the Internal Revenue Code, there is “active income” and “passive income”. The difference is not really in the income but in the treatment of the losses. Active losses have no limits and are deductible against all other income on the income tax return. Active losses can create Net Operating Losses, expenses greater than income, and carry those losses forward against future income in future years so you would pay less or no income taxes in the future. Say that you have a business that you run and report on your income tax return of Schedule C of Form 1040 and you have a loss. That creates an active loss and is available to offset all other income shown or reported on that tax return.

A passive loss is one where you have NO MATERIAL PARTICIPATION in the day-to-day activities, are not an “active member” of an LLC, and which, under the Internal Revenue Code must be offset against a specific type of passive income first, then other types of passive income and then the active income, but only up to a certain limit. The excess, which is not deductible in the current year, is carried forward and can be used against the profit when you sell the asset, like an apartment building.

So, please know whom you are talking to when you use the terms “active” and “passive” because CPAs look at it in one way, the way we're taught, and non-CPAs look at it in a totally different way, please don’t confuse us. We are confused enough already!!!

HAVE A WONDERFUL WEEKEND!!!

My name is Paul Levine, and I am a Commercial Realtor, a Residential Realtor of luxury homes in Southern California, a Real Estate Advisor, an Investment Advisor, and an Income Tax Consultant!!! You can call me at (818) 298 – 4000 after 10 AM Pacific Time Monday through Friday and, yes, even on the weekends. Or you can send an email to me at [email protected] and I will always try and answer you in a timely manner.