7914. How are income and expenses characterized for purposes of the passive loss rules?Nuco Employeercline212014-07-07T22:37:00Z2014-07-07T22:37:00Z25172949Summit Business Media246346014Site Map/Investments/Special Rules/Limitation on Loss Deductions/Passive Loss RuleTaxFactsDefaultArticle123231293-00-tf2.xml1293.00;#1958;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2Under the passive loss rule, what is a passive activity?44900.0000000000TaxFactsDefaultArticleSBMEDIA\moss-admin2010-01-14T23:01:08Z7914. How are income and expenses characterized for purposes of the passive loss rules?Certain income and expenses of a passive activity are not considered passive activity income or expenses in determining passive activity income and loss: income from interest, dividends, annuities, or royalties not derived in the ordinary course of a trade or business; expenses allocable to such income; and gain or loss not derived in the ordinary course of a trade or business that is attributable to the disposition of property either producing such income or held for investment. An interest in a passive activity is not treated as property held for investment. Income from the investment of working capital is not derived in the ordinary course of a trade or business.IRC Sec. 469(e).Interest deductions attributable to passive activities are subject to limitation under the passive loss rule, not under the investment interest limitation.IRC Sec. 163(d)(4)(D).In order to prevent taxpayers from defeating the purpose of the passive loss rules by structuring transactions to produce passive income from what are essentially active businesses or portfolio investments, Treasury was given very broad regulatory authority for carrying out the provisions of IRC Section 469. The IRC specifies that regulations may: provide that certain items of gross income will not be taken into account in determining income and loss from an activity, require that net income or gain from a limited partnership or other passive activity not be treated as passive income or loss, and allocate interest expense among activities.IRC Sec. 469(l). In the following instances, part or all of the income from a passive activity may be treated as income that is not from a passive activity: (1) the individual participates in such passive activity for more than 100 hours during the year, (2) less than 30 percent of the property used in a rental activity is depreciable property, (3) there is net interest income from a passive equity-financed lending activity, (4) rental of property developed by the taxpayer commenced within 12 months of disposition of such property, (5) the taxpayer rents property to a trade or business in which the taxpayer materially participates, and (6) the taxpayer acquires certain royalty interests in intangible property previously developed by a passthrough entity.Temp. Treas. Reg. §1.469-2T(f), Treas. Reg. §1.469-2(f).If gain is recognized in a taxable year beginning after 1986 with respect to an activity sold or exchanged before 1987, the gain is treated as passive if the activity would have been passive had the passive loss rule been in effect in the year the activity was sold or exchanged and in all succeeding years.TRA ’86 Sec. 501(c)(4) as amended by TAMRA ’88, Sec. 1005(a)(10).The Service has issued temporary and proposed regulations that provide complex tracing rules allocating interest expense (other than qualified residence interest) on the basis of the use of the proceeds of the underlying debt.Temp. Treas. Reg. §1.163-8T. (See Q 7924.) Once allocated, interest on proceeds used to purchase a passive activity is taken into account in determining income or loss from the activity. Characterization of interest on proceeds used to purchase a partnership or S corporation interest depends on whether the activity is passive to the partner or shareholder.Ann. 87-4, 1987-3 IRB 17.Income from discharge of indebtedness is generally characterized as income from a passive activity to the extent that the debt is allocated to passive activity expenditures.Rev. Rul. 92-92, 1992-25 CB 103.