Which of the following is true regarding passive losses?

Passive losses are generally associated with passive activities, which typically include rental activities and businesses in which the taxpayer does not materially participate. The correct assertion regarding passive losses is that they cannot be deducted against active income. This means that taxpayers cannot use losses from passive activities to offset income earned from active participation, such as wages, salaries, or other business income where the taxpayer is actively involved.

This treatment is a significant aspect of tax law and is designed to limit the ability of taxpayers to offset income from active sources with losses stemming from activities in which they do not have significant involvement. Passive losses can only offset passive income, and if there are no passive gains in a given year, those losses are not available to reduce the taxpayer’s overall taxable income.

In terms of tax planning, if passive losses exceed passive income, the excess losses are not lost; they are typically carried forward and can be utilized in future tax years when there may be passive income to offset or when the activity is disposed of. Thus, while the statement regarding them being carried forward has merit, it does not negate the fundamental rule that passive losses cannot be deducted against active income in the current year.