Video: Passive Activity Losses and Limitations

Nick Palazzolo, CPA, delves into the complexities of passive activity losses and limitations, providing a thorough breakdown of what constitutes a passive activity and how the IRS limits loss deductions. He brings clarity to the mom and pop exception, a vital piece of knowledge for understanding how small businesses can circumvent typical passive activity loss rules. Further, Nick lays out the criteria necessary for qualifying as a real estate professional, showing how this designation can transform rental losses into opportunities for offsetting income in other areas. Throughout the lesson, real-life scenarios and examples help demystify the rules, ensuring a solid grasp of how to handle rental real estate and passive income on taxes.

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Video Transcript

Instructor: Nick Palazzolo

Nick Palazzolo is head instructor of ExamPrep.ai CPA Review. Nick's teaching style is engaging & upbeat, combining practical Big 4 tax & assurance expertise with years of 1-on-1 coaching. His lessons are concise and emphasize what you need to know to pass. Whether you're a recent grad or working full-time, we’re confident you can conquer your CPA exams with Nick’s review.

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Passive activity, losses and limitations, and we're talking again here about nothing new. Passive activity losses, these are losses that arise from passive activity, such as rental, real estate, limited partnerships, or S-Corps, in which the taxpayer does not materially participate. The IRS limits the amount of passive activity losses that a taxpayer can deduct in a given year. It's a nice reintroduction to what we're gonna see. The mom and pop exception. This is something to know for sure. The mom and pop exception. Think mom and pop, why is it called that? Well, it's a mom and pop shop, it's a small shop. Small businesses, hence the name, applies to certain small businesses. These are often family owned and operated to avoid certain tax rules that would otherwise apply to larger businesses. Kind of the IRS trying to foster competition and allow smaller businesses to grow without heavy regulations and extra taxes like larger companies have. Specifically, this exception allows qualifying small businesses to avoid the passive activity loss rules that would limit their ability to deduct losses from their business activities against their other income. And obviously, we'll see examples how this works. You'll see questions on this on the exam, so make sure you are ready for it. Now, under the passive activity loss rules, losses from passive activities such as wrinkled real estate or limited partnerships can only be deducted against passive activity income. It's almost as if I'm saying these things one after another because you really need to know them. Ding, ding, ding. Any excess losses can be carried forward to future years or deducted when the taxpayer disposes of the passive activity. However, this mom and pop exception allows certain small businesses to treat their rental real estate activities as non-passive and

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Federal Taxation of Individuals: Passive Activity, & Tax Credits

Module: 2 Concepts, 28 Videos

Passive Activity Losses & Loss Limitations Overview

1:33

Introduction to Passive Activity Losses and Loss Limitations

7:43

Recourse vs. Nonrecourse Liabilities

6:01

Tax Basis vs. At-Risk Basis