In what situation would passive activity losses typically be limited?

Passive activity losses are typically limited when the taxpayer does not meet the thresholds for material participation in the activity. This rule is designed to prevent taxpayers from using losses from passive activities, such as rental properties or limited partnerships, to offset other types of income, such as wages or salaries.

In general, a taxpayer must actively participate in the management or operations of the business to deduct any losses associated with that activity. If the taxpayer fails to meet the necessary criteria for material participation, the losses incurred from passive activities cannot be used to reduce other taxable income. Instead, those losses may be carried forward to future tax years when the taxpayer can realize them against passive income.

The other options involve scenarios in which the taxpayer is engaging in active involvement or material participation and do not address the limitations placed on passive losses. Thus, the situation where taxpayer thresholds for participation are not met is the primary condition under which passive activity losses are limited.