Passive Losses Beyond Real Estate: K-1s, Oil and Gas, Equipment Leasing
Passive losses are not a real estate idea. Section 469 treats any trade or business you do not materially participate in as a passive activity, and every rental activity too (§469(c)(1), (2)). A K-1 from a business you don't work in, an equipment rental, or a non-working energy interest held through a partnership can all produce passive losses. And they all meet passive income from any source, including gain from selling a rental on the installment method.
This page describes how the tax law classifies those activities. It is not a list of things to buy, and nothing here says whether any investment fits you. That is a question for your investment adviser. The rules below apply once a loss is on your return.
The definition that reaches beyond real estate
A passive activity is either:
- a trade or business in which you do not materially participate (§469(c)(1)), or
- a rental activity, whether or not you participate (§469(c)(2)), unless you qualify as a real estate professional and materially participate (§469(c)(7)).
Material participation is decided by seven tests in Temp. Reg. §1.469-5T(a), such as more than 500 hours in the year. A limited partner can qualify under only three of them (Temp. Reg. §1.469-5T(e)(2)). For the full statute, see Section 469 passive activity rules.
The Loss Bank, a free guide, walks through these rules with worksheets for you and your CPA. Get The Loss Bank.
How §469 classifies common non-real-estate stakes
| Kind of stake | Passive when | Watch for |
|---|---|---|
| Business interests without material participation (limited or silent stakes in operating companies, S corporation shares, operating partnerships) | You don't materially participate (§469(c)(1)) | Seven tests decide participation; limited partners get three (Temp. Reg. §1.469-5T). |
| Equipment and other personal-property rentals (equipment leasing, aircraft, vehicles, boats) | It is a rental activity (§469(c)(2), (j)(8)) | If average customer use is 7 days or less, or 30 days or less with significant personal services, it is not a rental activity; it is passive only without material participation (Temp. Reg. §1.469-1T(e)(3)(ii)). |
| Energy interests held through a partnership, other than working interests | You don't materially participate | Credits are passive credits and reduce only tax on passive income (§469(a)(1)(B), (d)(2)). |
| Agricultural investor interests (farms, orchards, livestock) | You don't materially participate | The hobby-loss rule (§183) can limit an activity not engaged in for profit. |
| Film, media and similar partnerships | You don't materially participate | The at-risk rules name film and video, farming, equipment leasing and oil and gas among covered activities (§465(c)(1)). |
Oil and gas: the working-interest exception
Oil and gas is the one area where the classification flips.
- A working interest held directly, or through an entity that does not limit your liability, is not a passive activity, whether or not you participate (§469(c)(3)). Its losses are nonpassive and offset other income, and its later income is nonpassive too. It does not absorb passive losses.
- Royalties are portfolio income, not passive (Temp. Reg. §1.469-2T(c)(3)(i)(A)).
- A non-working interest held through a partnership or other business activity is the case that can produce passive income or loss, under the general rule.
Which of these describes a given interest is a question of the documents. Your CPA reads them.
Publicly traded partnerships stand alone
A loss from a publicly traded partnership can offset income only from that same partnership, until you dispose of your entire interest in it (§469(k)). It does not meet gain from selling a rental, even though both are passive.
Limits that apply before §469
A loss has to clear two tests before it reaches the passive loss rules at all:
- Basis in the activity.
- The at-risk rules of §465 (Temp. Reg. §1.469-2T(d)(6)).
A loss blocked there never becomes a passive loss carryover. See at-risk rules. And how activities are grouped (Reg. §1.469-4) decides what counts as one activity, and so what "your entire interest" means when one is sold.
Why installment gain meets these losses
Gain on disposing of property used in a passive activity is passive activity gross income, including depreciation recapture (Temp. Reg. §1.469-2T(c)(2)(i)(A)). Whether it is passive is fixed in the year of sale, so on an installment sale the gain recognized in each later year is passive too. Property that was nonpassive within 24 months before the contract can be treated as nonpassive (Reg. §1.469-2(c)(2)(iii)).
Passive losses from any passive activity are allowed against net passive income from all of them. So each year's installment gain from a passive rental can absorb that year's passive losses, and passive carryovers, from K-1 businesses, equipment rentals and non-working energy interests, not only from other buildings. The same is true of installment gain from selling a passive business interest.
The mirror image: when a non-real-estate passive activity is sold in a fully taxable sale of your entire interest to an unrelated buyer, its own suspended losses are freed (§469(g)(1)(A)), pro rata over the payments if the sale is on the installment method (§469(g)(3)).
The interest on the note is different. It is portfolio income, and passive losses cannot offset it (Temp. Reg. §1.469-2T(c)(3)).
The passive loss your return uses against one year's installment gain works like what The Loss Bank calls a scoop: one scoop a year, sized to that year's payment. Only the payment schedule is shaped, to the losses your CPA projects from activities already on your return. For how the release and absorption work on a note, see installment sales and passive losses and K-1 losses from real estate syndications.
What this page does not do
It does not suggest acquiring any interest to create losses. Whether any investment is suitable, what it costs, and what risks it carries are questions for your investment adviser, and they matter far more than the tax label. This page only explains the label.
Bottom line
Section 469 reaches any business you don't materially participate in and any rental activity, not only real estate. Oil and gas working interests are carved out as nonpassive; royalties are portfolio income; publicly traded partnership losses stay inside their own partnership. Installment gain from a passive activity is passive in every year it is recognized, so it can absorb passive losses from any passive activity already on your return.
The Loss Bank, a free guide, walks through these rules with worksheets for you and your CPA. Get The Loss Bank.
Questions to ask your CPA
- Which of my K-1 activities are passive, and do I materially participate in any?
- Is any energy interest I hold a working interest under §469(c)(3)?
- Are any of my losses limited by basis or at-risk rules before §469?
- Do I hold any publicly traded partnership interests with suspended losses?
- How are my activities grouped under Reg. §1.469-4?
- How much passive carryover can each year's installment gain absorb?
For your CPA: §469(a)(1)(B), (c)(1)-(3), (c)(7), (d)(2), (g)(1)(A), (g)(3), (j)(8), (k); Temp. Reg. §§1.469-1T(e)(3)(ii), 1.469-2T(c)(2)(i)(A), (c)(3)(i)(A), (d)(6), 1.469-5T(a), (e)(2); Reg. §§1.469-2(c)(2)(iii), 1.469-4; §§465(c)(1), 183.
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Educational only, not tax, legal or investment advice. Examples are illustrative. Have your CPA or tax attorney review your facts before you act. Hans Goldstein is a licensed insurance agent (CA Insurance License #4273294) and is not a CPA or attorney. He is paid a commission only if a structured installment sale is funded; seller financing pays him nothing. Disclosures.