Legal Definitions - passive activity

A passive activity refers to a business or income-producing venture in which an individual invests capital but does not significantly or regularly participate in its day-to-day operations or management. For tax purposes, this means the taxpayer is not actively involved in a substantial way in generating the income from that activity.

• Example 1: Limited Partner in a Restaurant

  Sarah invests a significant sum as a limited partner in a new local restaurant. While she provides crucial funding, her agreement specifies that she will have no involvement in hiring staff, managing daily operations, ordering supplies, or making strategic business decisions. She relies entirely on the general partners to run the business.

  Explanation: Sarah's income from the restaurant is considered a passive activity because she does not materially participate in its ongoing business operations. Her role is purely financial, providing capital without engaging in the active management or work of the enterprise.

• Example 2: Owner of a Self-Storage Facility with Third-Party Management

  David purchases a self-storage facility as an investment. However, he lives in a different state and hires a professional property management company to handle all aspects of its operation. This company is responsible for renting units, collecting payments, performing maintenance, and providing customer service.

  Explanation: Although David owns the asset and receives income from it, he does not personally manage the facility or participate in its daily business activities. The management company performs all the active work. Because David does not materially participate in the operation of the storage facility business, the income he receives from it is classified as passive.