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Table of Contents

List of Forms by Chapter

Chapter 1 — Considerations In Electing S Corporation Status

Chapter 2 — Electing S Corporation Status

Chapter 3 — Operating and Maintaining the S Corporation

Chapter 4 — Passive Loss Rules: Application to an S Corporation and Its Shareholders

Chapter Summary

I. [4.1] Introduction

II. [4.2] Background

III. [4.3] Applying the Regulations

[4.4] What the Taxpayer Is Trying To Determine

[4.5] Passive Activity Losses Checklist

[4.6] Step One — Determine Whether the Taxpayer Is Subject to Internal Revenue Code §469

[4.7] Step Two — Determine the Separate Activities of the Taxpayer

[4.8] General Activity Rules

[4.9] Grouping Activities

[4.10] Limitations on Grouping Rental Activities

[4.11] Activities of Certain Limited Partners and Limited Entrepreneurs

[4.12] Activities Conducted Through Entities

[4.13] Certain Trading Activities

[4.14] Consistency Requirements

[4.15] Grouping by the Internal Revenue Service To Prevent Tax Avoidance

[4.16] Reporting Groupings

[4.17] Step Three — Determine Whether the Taxpayer Materially Participates

[4.18] Participation

[4.19] Material Participation Tests

[4.20] Significant Participation

[4.21] Personal Service Activity

[4.22] Facts and Circumstances Test

[4.23] Step Four — Determine Whether the Activity Is a Rental Activity

[4.24] Exceptions to General Rule

[4.25] Average period of customer use

[4.26] Average customer use of seven days or less

[4.27] Average customer use of 30 days or less with significant personal services

[4.28] Extraordinary personal services are provided

[4.29] Rental incidental to non-rental activities

[4.30] Property customarily made available for nonexclusive use by various customers

[4.31] Property provided to partnership or S corporation in which taxpayer owns an interest

[4.32] Exception for Rental Real Estate Activities of Real Estate Professionals

[4.33] Limited Exception for Active Participation in Rental Real Estate

[4.34] Step Five — Eliminate Nonpassive Income

[4.35] Portfolio Income

[4.36] Personal Service Income

[4.37] Self-Charged Items

[4.38] Gross Income from Oil and Gas Properties

[4.39] Additional Exclusions from Passive Activity Gross Income

[4.40] Step Six — Determine Applicability of Recharacterization Rules

[4.41] Significant Participation

[4.42] Non-Depreciable Rental Property

[4.43] Interest Income from Passive Equity-Financed Lending Activity

[4.44] Income from Property Rented Incidental to Development Activity

[4.45] Self-Rented Property

[4.46] Pass-Through Entities Licensing Intangible Property

[4.47] Additional Situations Subject to Recharacterization

[4.48] Substantially appreciated property formerly used in nonpassive activity

[4.49] Qualified working interests in oil and gas

[4.50] Active participation rental real estate

[4.51] Step Seven — Calculate the Passive Loss

[4.52] Calculate Passive Activity Deductions

[4.53] Calculate Passive Activity Gross Income

[4.54] Gain from disposition of an interest in an activity or an interest in property used in an activity

[4.55] Income from Internal Revenue Code §481 adjustments

[4.56] Overall Net Loss

[4.57] Net Loss for Each Activity

[4.58] Loss Carryover

[4.59] Step Eight — Apply Passive Activity Losses Following Disposition of an Activity

[4.60] Sales

[4.61] Gifts

[4.62] Inheritance

[4.63] Former Passive Activities

[4.64] Partial Dispositions

[4.65] Installment Sales

[4.66] Disposition of Interest in Pass-Through Entity

[4.67] Conversion of C Corporation to S Corporation

[4.68] Treatment of Passive Activity Credits

IV. [4.69] Conclusion

Authors

Janelle N. Darnell
Janelle N. Darnell
Janelle N. Darnell is an Associate at McGuireWoods LLP, in Chicago, where she focuses her practice on taxation and mergers and acquisitions, and she will be a Partner as of January 1, 2026. Darnell is a member of the Illinois State Bar Association and the American Bar Association, and she was recognized as a Nolan Fellow by the American Bar Association’s Tax Section for the 2023 – 2024 fiscal year. She currently serves as Vice-Chair of the ABA Tax Section’s S Corporations Committee, and she is the incoming Chair of the Committee for the 2026 – 2027 fiscal year. Darnell received a B.A. from California Polytechnic State University, an M.B.A. from San Diego State University, a J.D. from the University of San Diego School of Law, and an LL.M. from the Northwestern University Pritzker School of Law.
Paul S. Drizner
Paul S. Drizner
Paul S. Drizner is a Partner in the Chicago office of Seyfarth Shaw LLP, where he concentrates his practice in taxation. Drizner is a member of the American Bar Association. He received his B.S. from the University of Illinois and his J.D. from Loyola University Chicago School of Law, where he served as an editor on the Loyola University Chicago Law Journal.
Anthony J. Jacob
Anthony J. Jacob
Anthony J. Jacob is a Partner at Hinshaw & Culbertson LLP, in Chicago, and concentrates his practice in business law, banking and commercial finance law, real estate law, and election law. In 2013 and 2014, respectively, Jacob was appointed as a member of the investment committee for the board of trustees at the University of Illinois Chicago School of Law (formerly known as the John Marshall Law School) and as a board member at the Institute of Illinois Business Law at Chicago-Kent College of Law. He has previously chaired the Business and Securities Law Section Council of the Illinois State Bar Association. Jacob received his B.A. at Northern Illinois University and both his LL.M. and J.D. from the University of Illinois Chicago School of Law, where he was Student Publications Editor of the UIC Law Review and a member of the moot court team.
Alexander Loftus
Alexander Loftus
Alexander Loftus is a Partner at Loftus & Eisenberg, Ltd., in Chicago, where he focuses his practice on business litigation. Loftus has been named a Super Lawyer and is a member of the Illinois Trial Lawyer’s Association, the Illinois State Bar Association, and the Small Business Advisory Counsel. He received his J.D. from DePaul College of Law.

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S Corporations 2026 Edition

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