Question

When the passive activity is sold, any suspended passive losses can be utilized against ordinary income. Losses must clear the basis and at-risk hurdles first. Passive losses are generally limited to passive income. What is the offset against ordinary income when the passive activity is disposed?

1) Offset against passive income
2) Offset against active income
3) Offset against capital gains
4) Offset against investment income

Answer 1

When a passive activity is sold, any suspended passive losses can be utilized against ordinary income, but they must clear the basis and at-risk hurdles first. Passive losses are generally limited to passive income, so the offset is against active income.

Step-by-step explanation:

When a passive activity is sold, any suspended passive losses can be utilized against ordinary income. However, before these losses can offset ordinary income, they must clear two hurdles: the basis hurdle and the at-risk hurdle. The basis hurdle is the amount of the investment that has not yet been deducted as losses, while the at-risk hurdle is the amount of the investment that the taxpayer is personally liable for.

Once the losses have cleared these hurdles, they can be used to offset ordinary income. Passive losses are generally limited to passive income, so if there is no passive income to offset, the losses may be carried forward to future years to offset future passive income. Therefore, the correct answer is 2) Offset against active income.