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Tax Compliance and Planning/Blueprint/1.B

Passive activities and at-risk limitations

Area 1: Individual Tax Planning (30-40%)

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Topics

  • Passive activity loss rules (Section 469)
  • At-risk limitations (Section 465)
  • Real estate professional exception

Lessons

  • Passive Activity and At-Risk Rules

Study Frameworks

Loss Limitation Ordering Rules

Loss Limitation Hierarchy (applied in order)
1. Tax Basis Limitation
S corp: stock basis + debt basis (direct loans only)
Partnership: outside basis (includes partner's share of all liabilities)
Losses exceeding basis are suspended and carried forward indefinitely
2. At-Risk Limitation (IRC 465)
Amount at risk = cash invested + recourse debt + qualified nonrecourse financing (real estate)
Losses limited to amount at risk
Suspended losses freed up when at-risk amount increases
3. Passive Activity Loss Limitation (IRC 469)
Passive losses offset only passive income
Exception: $25,000 rental real estate allowance (phases out $100K-$150K AGI)
Real estate professionals exempt if material participation
Suspended losses released on fully taxable disposition
4. Excess Business Loss Limitation (IRC 461(l))
Noncorporate taxpayers: losses exceeding threshold become NOL carryforward
Threshold: $322,000 single / $644,000 MFJ (2026, indexed)
Applied after passive activity rules

Passive vs. Active — Material Participation Test Flow

Did the taxpayer participate in the activity for more than 500 hours during the tax year?
Yes
Material participation met — income/loss is nonpassive (active)
No
Was the taxpayer's participation substantially all of the participation by all individuals (including non-owners)?
Yes
Material participation met — income/loss is nonpassive
No
Did the taxpayer participate more than 100 hours AND at least as much as any other individual?
Yes
Material participation met — income/loss is nonpassive
No
Did the taxpayer materially participate in any 5 of the prior 10 tax years?
Yes
Material participation met — income/loss is nonpassive
No
Material participation NOT met — activity is passive (losses subject to PAL rules under IRC 469)

Material Participation Tests (IRC 469)

Test #DescriptionHours/Criteria
1Participation exceeds 500 hours500+ hours during the tax year
2Substantially all participationTaxpayer's participation constitutes substantially all participation by all individuals
3Significant participation + most of any person100+ hours AND not less than any other individual
4Significant participation activities aggregateAll significant participation activities (100+ hrs each) total 500+ hours
5Material participation in 5 of prior 10 years5 of the 10 preceding tax years
6Personal service activity — 3 prior yearsAny 3 preceding tax years (for personal service activities only)
7Facts and circumstancesRegular, continuous, and substantial involvement (100+ hours, but never if <100 hours)
BAP-EBasis, At-risk, Passive activity, Excess business loss

The mandatory ordering of loss limitation rules. Each limitation is applied in sequence: losses must first pass the basis test, then at-risk, then passive activity, and finally excess business loss.

FACETSFive hundred hours, All participation, Cent (100) hours + most, Earlier 5 of 10 years, Three prior years (PSA), Substantial involvement (facts)

Memory aid for the material participation tests under IRC 469. Meeting any single test establishes material participation and makes the activity nonpassive.

Practice These Topics(128 questions)