Passive Activity — Glossary — IRS Depreciation Rules

Passive Activity

Under IRC §469, a trade or business activity in which the taxpayer does not materially participate, or — with limited exceptions — any rental activity. Losses from passive activities can offset only passive income; suspended losses carry forward indefinitely and release on disposition. The §469 rules are the primary gating mechanism for cost segregation deductibility.

STATUTE BASIS · IRC §469 · Treas. Reg. §1.469-1 through §1.469-11

In context

§469 was enacted by the Tax Reform Act of 1986 to curb tax-shelter losses. Two categorical rules drive most outcomes for real estate:

Rental activities are presumptively passive under §469(c)(2), regardless of the taxpayer’s level of participation — unless the taxpayer qualifies as a real estate professional under §469(c)(7).
Short-term rentals are not “rental activities” for §469 purposes when average customer use is seven days or fewer (Treas. Reg. §1.469-1T(e)(3)(ii)(A)). The activity is then evaluated under the standard material participation tests.

Cost segregation typically generates a large first-year deduction. Whether that deduction offsets ordinary income (active treatment) or only passive income (passive treatment) determines whether the taxpayer captures the deduction in year one or carries it forward.

The §469 active-versus-passive determination is a return-position decision owned by the taxpayer’s CPA, not the cost segregation provider.

See /passive-activity/ for the full topic hub.