Passive Activity

General Rules NII generally includes income and gain from passive activities. A passive activity for purposes of NII has the same meaning as under section 469. A passive activity includes any trade or business in which you don’t materially participate. A passive activity also includes any rental activity, regardless of whether you materially participate. There are limited exceptions for rentals. See the discussion on rentals, later. For more details on passive activities, see the Instructions for Form 8582, Passive Activity Loss Limitations; and Pub. 925, Passive Activity and At-Risk Rules.

Trade or Business Activities The definition of trade or business for NIIT purposes is limited to a trade or business within the meaning of section 162. This is more restrictive than the definition of a trade or business activity for purposes of the passive activity loss rules. For example, under the passive activity loss rules, a trade or business includes any activity conducted in anticipation of the commencement of a trade or business and any activity involving research or experimentation. In some cases, income from activities that aren’t passive activities under section 469 will be included in NII because the activity doesn’t rise to the level of a trade or business within the meaning of section 162. The activity must be a trade or business within the meaning of section 162 and be nonpassive for purposes of section 469 before the income is excluded from the NIIT (with the exception of a trade or business of trading in financial instruments or commodities under section 1411(c)(2)(B)). If you own an interest in a pass-through entity, the determination of whether that’s a trade or business is made at that entity’s level.

Real Estate Professionals If you’re a real estate professional for purposes of section 469(c)(7), your rental income or loss won’t be passive if you materially participated in the rental real estate activity with certain restrictions. See Safe Harbor for Real Estate Professionals , below.

However, your rental income is included in NII if the income isn’t derived in the ordinary course of a trade or business. Qualifying as a real estate professional doesn’t necessarily mean you’re engaged in a trade or business with respect to the rental real estate activities. If your rental real estate activity isn’t a section 162 trade or business or you don’t materially participate in the rental real estate activities, the rental income will be included in NIIT.

For additional information on real estate professionals, see section 469(c)(7) and Pub. 925.

• Participated in a rental real estate activity for more than 500 hours in any 5 tax years (whether or not consecutive) during the 10 tax years immediately prior to this tax year.

If you qualify, your gross rental income from your rental real estate activity is treated as though derived in the ordinary course of a trade or business and isn’t included in your NII. If you qualify in the year you dispose of the property used in the rental real estate activity, the amount of gain or loss from the disposition is also deemed to be derived from property used in the ordinary course of a trade or business and isn’t included in your NII.

Note: For real estate professionals with a Regulations section 1.469-9(g) election in effect, all of your rental real estate activities constitute a single activity for purposes of applying the 500-hour test described under Safe Harbor for Real Estate Professionals above.

Note: If you’re a real estate professional under section 469(c)(7), but you’re unable to satisfy the qualifications for the safe harbor, you’re not precluded from establishing that the gross income and gain or loss from the disposition of property associated with your rental real estate activity aren’t included in NII.

Special Rules for Certain Rental Income For income tax purposes, Regulations section 1.469-2(f) (6) generally recharacterizes what would otherwise be passive rental income from a taxpayer’s property as nonpassive where the taxpayer rents the property for use in a trade or business in which the taxpayer materially participates and the use of the rental property is not incidental to development activity.

Similarly, for income tax purposes, a rental activity that’s properly grouped with a trade or business activity in which the taxpayer materially participates under Regulations section 1.469-4(d)(1) is a nonpassive activity. For purposes of calculating your NII, the gross rental income in both of these situations is treated as though it’s

Safe Harbor for Real Estate Professionals You qualify for the safe harbor if you’re a real estate professional for purposes of section 469 and you:

• Participate in each rental real estate activity for more than 500 hours during the tax year, or

4 Instructions for Form 8960 (2025)

derived in the ordinary course of a trade or business. Further, upon the disposition of the assets associated with the rental activity, any gain or loss is also treated as gain or loss attributable to the disposition of property held in a nonpassive trade or business and not included in your NII. For these purposes, the nonpassive trade or business can’t be a business trading in financial instruments or commodities.

Special Rules for Certain Farming Operations Net income from a farm that is actively managed, for example, where the owners meet material participation tests, is not subject to NIIT. Farm income from a passive activity is subject to the tax under section 1411(c)(2). However, income taken into account in figuring self-employment income that is subject to tax under section 1401(b) is not subject to NIIT. See Special Rule for Self-employed Individuals , later.

Treatment of Former Passive Activities A former passive activity is any activity that was a passive activity in a prior tax year but isn’t a passive activity in the current year. A prior tax year’s unallowed loss from a former passive activity is allowed to the extent of current-year income from the activity under section 469(f) (1)(A). For purposes of determining your NII, suspended losses from former passive activities are allowed as a properly allocable deduction, but only to the extent the net income or net gain from the former passive activity is included in your NII. Any remaining suspended losses from the former passive activity are allowed as a properly allocable deduction, but only to the extent the net income or net gain from other passive activities is included in your NII. For more information, see Regulations section 1.1411-4(g)(8) and examples.

Disposition of Entire Interest If you disposed of your entire interest in a passive activity or a former passive activity to an unrelated person in a fully taxable transaction, your losses allocable to the activity for that year aren’t limited by the passive activity loss rules for income tax purposes. A fully taxable transaction is a transaction in which you recognize all realized gain or loss. For purposes of calculating your NII, these losses may be properly allocable deductions, depending on the underlying character and origin of the losses.

Note: If you dispose of an activity that’s always been a passive activity, the suspended passive losses from that activity are allowed in full as a properly allocable deduction.

Note: If you dispose of an activity that’s a former passive activity, any suspended passive losses allowed in the year of disposition by reason of section 469(f)(1)(A) are included as properly allocable deductions, but only to the extent the gain on the disposition of the activity is included in NII (before taking into account any suspended losses). Any suspended passive losses that are allowed by reason of section 469(g) are allowed as additional properly allocable deductions.

Economic Grouping You can treat one or more trade or business activities, or rental activities, as a single activity if those activities form an appropriate economic unit for measuring gain or loss under the passive activity loss rules. For additional information on passive activity grouping rules, see Pub. 925.

Regrouping rules. The passive activity grouping rules determine the scope of your trade or business and whether that trade or business is a passive activity for purposes of the NIIT. The proper grouping of a rental activity with a trade or business activity won’t generally convert any gross income from rents into gross income derived from a trade or business.

Generally, you may not regroup activities unless your grouping was clearly inappropriate when originally made, or has become clearly inappropriate because of changed facts and circumstances.

However, under the NIIT “fresh start” election, you may regroup for the first tax year you’re subject to the NIIT (without the effect of the regrouping). You may regroup only once under this election and that regrouping will apply to the tax year for which you regroup and all future tax years. If you’re subject to the NIIT for 2013 and you don’t regroup, you may make the election for the first tax year beginning after 2013 that you’re subject to the NIIT.

You may regroup on an amended return, but only if you weren’t subject to the NIIT on your original return (or previously amended return), and if, because of a change to the original return, you owe NIIT for the year. For additional rules regarding regrouping on amended returns, see Regulations section 1.469-11(b)(3)(iv)(C).

Disclosure requirements. Regroupings under the NIIT “fresh start” election are subject to the disclosure requirements of Rev. Proc. 2010-13.