Despite the chummy-sounding acronym, PALs (short for passive-activity losses) are anything but friendly to taxpayers, particularly those who invest in real estate. Fortunately, you can gain more tax saving value from your PALs with some astute tax planning.
The rules on passive-activity losses
Normally, you can use losses from investments to offset your highly taxed ordinary income, such as the salary from your job. But the PAL rules say that you can use losses from "passive" activities only to offset income from other passive activities. Any excess passive loss for the year is suspended and must be carried forward to future years. Similar rules apply to applicable tax credits.
So, what is a "passive" activity? It's a trade or business in which you don't "materially participate." For example, a business that you own but is run strictly by employees is considered a passive activity.
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